Financial Management
Exam Answer Key
Course Introduction
Financial Management offers an in-depth understanding of how organizations plan, direct, and control their financial resources. The course examines key principles such as capital budgeting, risk analysis, time value of money, financial statement analysis, and optimal capital structure. Students will explore methods for evaluating investment opportunities, managing working capital, securing funding, and maximizing shareholder value. By developing both theoretical knowledge and practical skills, this course equips learners to make informed financial decisions within corporate, governmental, or nonprofit settings.
Recommended Textbook Fundamentals of Investments 6th Edition by
Bradford D. Jordan
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Page 2
Chapter 1: A Brief History of Risk and Return
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Q1) You own a stock that has produced an arithmetic average return of 7.8 percent over the past five years. The annual returns for the first four years were 16, 11, -19, and 3 percent, respectively. What was the rate of return on the stock in year five?
A) -5.00 percent
B) 2.75 percent
C) 6.25 percent
D) 28.00 percent
E) 32.00 percent
Answer: D
Q2) The capital gains yield is equal to:
A) (P<sub>t</sub> - P<sub>t + 1</sub> + D<sub>t + 1</sub>)/P<sub>t + 1</sub>.
B) (P<sub>t + 1</sub> - P<sub>t</sub> + D<sub>t</sub>)/P<sub>t</sub>.
C) D<sub>t + 1</sub>/P<sub>t</sub>.
D) (P<sub>t + 1</sub> - P<sub>t</sub>)/P<sub>t</sub>.
E) (P<sub>t + 1</sub> - P<sub>t</sub>)/P<sub>t + 1</sub>.
Answer: D
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Chapter 2: The Investment Process
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Q1) To be considered liquid, a security must:
A) be held in a cash account.
B) pay dividends.
C) be able to be sold on short notice.
D) be held for less than one year.
E) be able to be sold quickly with little, if any, price concession.
Answer: E
Q2) Brooke has decided to invest 55 percent of her money in large company stocks, 40 percent in small company stocks, and 5 percent in cash. This is a(n) _____ decision.
A) market timing
B) security selection
C) tax-advantaged
D) active strategy
E) asset allocation
Answer: E
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Chapter 3: Overview of Security Types
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Sample Questions
Q1) Preferred stock:
A) is a type of corporate debt.
B) is treated like debt for tax purposes.
C) is listed in the liabilities section of a balance sheet.
D) has a stated dividend but no stated liquidation value.
E) is treated like equity for both tax and accounting purposes.
Answer: E
Q2) You purchased 500 shares of SLG, Inc. stock at a price of $40.20 a share. You then purchased put options on your shares with a strike price of $47.50 and an option premium of $1.90. At expiration, the stock was selling for $48.30 a share. You sold your shares on the option expiration date. What is your net profit or loss your transactions related to SLG, Inc. stock?
A) $2,650
B) $2,250
C) $3,100
D) $3,550
E) $3,700
Answer: C
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Chapter 4: Mutual Funds
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Sample Questions
Q1) Mutual fund trading costs:
A) are computed as a percentage of a fund's assets.
B) are generally set at a flat amount per year.
C) generally include a bonus fee for outperforming an index.
D) increase in direct relation to the turnover rate.
E) are the costs paid to brokers in the form of sales commissions.
Q2) The High Yield Money Market Fund returned 5.75 percent for the last year. Currently, you own 9,042.08 shares of this fund. If you invested in this fund one year ago, what was the amount of your original investment?
A) $8,350.00
B) $8,402.38
C) $8,550.43
D) $8,750.00
E) $9,650.03
Q3) Letter grades are most frequently assigned to mutual funds based on the fund's:
A) projected future returns.
B) historical rates of return.
C) management style.
D) portfolio size.
E) investment objective.
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Chapter 5: The Stock Market
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Sample Questions
Q1) Assume the DJIA closed at 12,487 last night. The divisor is 0.123017848. Assume that 29 of the stocks in the index were unchanged today. One stock increased in value from $54.80 a share yesterday to $57.90 a share today. What is the DJIA index value at the close of trading today?
A) 12,504
B) 12,508
C) 12,509
D) 12,512
E) 12,524
Q2) A price-weighted index consists of stocks A, B, and C which are priced at $27, $11, and $18 a share, respectively. The current index divisor is 2.24. If stock B undergoes a 1-for-3 reverse stock split, the new index divisor will be:
A) 1.9467.
B) 2.1806. C) 2.2000.
D) 3.0842. E) 3.1200.
Q3) Explain the NYSE uptick rule and the current controversy pertaining to that rule.
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Chapter 6: Common Stock Valuation
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Sample Questions
Q1) You would like to know the value of a firm's equity today in relation to the cost of that equity. Which one of the following ratios will provide you with this information?
A) price-earnings
B) price-book
C) price-sales
D) price-cash flow
E) price-assets
Q2) Roy's Markets has net income of $164,000. The firm has 200,000 shares of common stock outstanding. The dividend for this year is $0.61 per share. What is the retention ratio?
A) .220
B) .256
C) .314
D) .774
E) .780
Q3) Identify three causes for a decrease in a firm's sustainable rate of growth.
Q4) The residual income model for valuing a stock suffers from some of the same estimating errors as the dividend growth model. Identify and explain these estimating errors.
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Chapter 7: Stock Price Behavior and Market Efficiency
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Sample Questions
Q1) In an efficient market, daily abnormal returns:
A) are very volatile.
B) reflect news within the past week.
C) reflect news since the prior trading day.
D) remain constant.
E) do not exist.
Q2) Which of the following will lead to excess profits in a semistrong-form efficient market?
I. private financial information
II. historical price trends
III. financial analysts reports
IV. unreleased merger plans
A) I only
B) I and IV only
C) II and III only
D) I, II, and III only
E) I, III, and IV only
Q3) What are some of the key lessons to be learned from historical stock market crashes?
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Page 9
Chapter 8: Behavioral Finance and the Psychology of Investing
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Sample Questions
Q1) According to Dow theory, which one of the following is the primary means of eliminating secondary market trends?
A) corrections
B) confirmations
C) continuations
D) conversions
E) coordinated trades
Q2) You recently heard a news announcer state that the market is approaching its support level. Which one of the following is the best interpretation of that statement?
A) The market is approaching the lowest level that is reasonably expected.
B) The federal government will step in to help the market retain its value should the market slip much further.
C) The market is almost at a peak and is expected to start declining in the near future.
D) The market is almost to the point where trading will be suspended temporarily.
E) The market is almost equivalent in value to the international markets so price stabilization is expected.
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Chapter 9: Interest Rates
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Sample Questions
Q1) Which one of the following is the largest market in the world for new debt securities with maturities of one year or less?
A) commercial paper
B) U.S. Treasury bill
C) banker's acceptance
D) Eurodollar money market
E) certificates of deposit
Q2) Which one of the following rates is the rate a commercial bank must pay the Federal Reserve to borrow reserves overnight?
A) discount
B) Fed funds
C) financial overnight
D) daily
E) institutional
Q3) Identify and describe four of the six components of nominal interest rates as supported by modern term structure theory.
Q4) Write a short paragraph comparing a bank discount rate to a bond equivalent rate.
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11
Chapter 10: Bond Prices and Yields
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Sample Questions
Q1) A bond has a Macaulay duration of 7.5, a yield to maturity of 6.6 percent, a coupon rate of 7.5 percent, and semiannual interest payments. What is the bond's modified duration?
A) 6.59 years
B) 6.84 years
C) 6.92 years
D) 7.06 years
E) 7.26 years
Q2) You are considering two bonds. Both have semi-annual, 8 percent coupons, $1,000 face values, and yields to maturity of 7.5 percent. Bond S matures in 4 years and Bond L matures in 8 years. What is the difference in the current prices of these bonds?
A) $10.51
B) $11.33
C) $11.52
D) $12.67
E) $12.88
Q3) Josh is saving money to purchase a home in 9 years. Explain why Josh should create a coupon bond portfolio with a duration of 9 years, rather than purchasing coupon bonds that mature in 9 years.
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Page 12
Chapter 11: Diversification and Risky Asset Allocation
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Q1) Which one of the following statements must be true?
A) All securities are projected to have higher rates of return when the economy booms versus when it is normal.
B) Considering the possible states of the economy emphasizes the fact that multiple outcomes can be realized from an investment.
C) The highest probability of occurrence must be placed on a normal economy versus either a boom or a recession.
D) The total of the probabilities of the economic states can vary between zero and 100 percent.
E) Various economic states affect a portfolio's expected return but not the expected level of risk.
Q2) Tall Stand Timber stock has an expected return of 17.3 percent. What is the risk-free rate if the risk premium on the stock is 12.4 percent?
A) 4.90 percent
B) 5.30 percent
C) 5.67 percent
D) 6.55 percent
E) 7.17 percent
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13
Chapter 12: Return, Risk, and the Security Market Line
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Sample Questions
Q1) Which one of the following will increase the slope of the security market line? Assume all else constant.
A) increasing the beta of an efficiently-priced portfolio
B) increasing the risk-free rate
C) increasing the market risk premium
D) decreasing the market rate of return
E) replacing a low-beta stock with a high-beta stock within a portfolio
Q2) The risk-free rate is 3.1 percent and the expected return on the market is 11 percent. Stock A has a beta of 1.34. For a given year, Stock A returned 16.7 percent while the market returned 12.2 percent. The systematic portion of Stock A's unexpected return was _____ percent and the unsystematic portion was _____ percent.
A) 1.41; 1.61
B) 1.61; 1.41
C) 1.61; 3.01
D) 1.41; 1.20
E) 4.62; 1.41
Q3) Identify and describe each of the three components of a security's expected return according to the capital asset pricing model.
Q4) Explain the relationship between the security market line and market efficiency.
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Chapter 13: Performance Evaluation and Risk Management
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Sample Questions
Q1) Which one of the following concerns a money manager's control over investment risks, particularly potential short-run losses?
A) Alpha management
B) Normal distribution management
C) Investment risk management
D) Raw return distributions
E) Volatility performance measures
Q2) The one-year standard deviation of your portfolio is 16.4 percent. What is the two-year standard deviation?
A) 17.47 percent
B) 19.23 percent
C) 23.19 percent
D) 25.41 percent
E) 27.20 percent
Q3) Explain a key advantage and a key disadvantage of Jensen's alpha.
Q4) Explain the similarities and differences between the Sharpe and Treynor ratios. Also, explain the most appropriate application for each.
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Chapter 14: Futures Contracts
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Sample Questions
Q1) Which one of the following is the definition of maintenance margin?
A) initial amount required when a futures contract is either bought or sold
B) maximum amount of margin permitted for a futures account
C) minimum margin required in a futures account at all times
D) the additional amount requested in a margin call
E) the minimum amount needed to reverse a futures position
Q2) Which one of the following statements related to futures contracts is correct?
A) The buyer of the contract has a short position.
B) The buyer of the contract has the right to either accept delivery or cancel the contract.
C) Futures contracts can be cancelled by either the buyer or the seller with 10 days notice to the other party.
D) Both the buyer and the seller of the contract are obligated to fulfill their duties as outlined in the futures contract.
E) The buyer of the contract must deliver the underlying asset on the settlement date.
Q3) You are the chief financial officer (CFO) of a major textile importer. Identify one of the key risks your company faces and explain how you can hedge this risk using futures.
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Page 16
Chapter 15: Stock Options
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Q1) Which one of the following terms is defined as an option that would have a positive payoff if exercised now?
A) in-the-money option
B) out-of-the-money option
C) straddle
D) crossed option
E) cash-settled
Q2) A stock is currently selling for $26.50. A 2-month put option with a strike price of $30 has an option premium of $4.15. The risk-free rate is 2.5 percent and the market rate is 9.75 percent. What is the option premium on a 2-month call with a $30 strike price? Assume the options are European style.
A) $0.00
B) $0.33
C) $0.41
D) $0.67
E) $0.77
Q3) You wrote a put with a strike price of $20 and a premium of $1. Draw a graph depicting your profits or losses for stock prices ranging from $0 to $40. Be sure to completely label your graph.
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Chapter 16: Option Valuation
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Sample Questions
Q1) Which one of the following statements concerning option prices is correct?
A) There is a relatively linear direct relationship between the volatility of the underlying stock price and option prices.
B) Call option prices decrease and put option prices increase as the time to expiration increases.
C) Put option prices are directly related to the price of the underlying stock.
D) The relationship between option prices and stock prices is a linear relationship.
E) Delta measures the effect that the underlying stock's dividend yield has on option prices.
Q2) Laura has an equity portfolio valued at $11.2 million that has a beta of 1.32. She has decided to hedge this portfolio using SPX call option contracts. The S&P 500 index is currently 1402. The option delta is .582. How many option contracts must Laura write to effectively hedge her portfolio?
A) 37 contracts
B) 42 contracts
C) 175 contracts
D) 181 contracts
E) 191 contracts
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Chapter 17: Projecting Cash Flow and Earnings
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Q1) Behrend Corporation has annual sales of $5.5 million, depreciation of $475,000, operating expenses of $689,000, cost of goods sold of $2.3 million, and interest expense of $230,000. What is the operating income?
A) $1,911,000
B) $2,036,000
C) $3,525,000
D) $4,000,000
E) $4,811,000
Q2) Last year, a firm had net income of $62,000 on sales of $595,000. The projected sales for next year are $654,500. Assume the firm uses the percentage of sales method for pro forma statements. What is the projected net income?
A) $59,500
B) $65,500
C) $68,200
D) $71,500
E) $71,900
Q3) Explain the role the external financing need plays in the future growth outlook for a firm.
Q4) Why is the expected rate of sales growth so critical to pro forma statements?
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Chapter 18: Corporate Bonds
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Sample Questions
Q1) What is the conversion ratio of a $1,000 par value bond that is selling for $888.96 and has a conversion price of $58.82?
A) 15
B) 16
C) 17
D) 18
E) 19
Q2) A semi-annual coupon bond has a 6.5 percent coupon rate, a $1,000 face value, a current value of $1,054.54, and 4 years until the first call date. What is the call price if the yield to call is 6.7 percent?
A) $1,000
B) $1,020
C) $1,040
D) $1,060
E) $1,080
Q3) How is the minimal value for a convertible bond determined?
Q4) Why do corporations, rather than individuals, tend to be the largest holders of preferred stock?
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Chapter 19: Government Bonds
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Questions
Q1) You own a principal STRIPS which is based on a 4.5 percent coupon Treasury bond that matures in 20 years. The STRIPS is priced at $22,868 and has a par value of $50,000. What is the yield to maturity on the STRIPS?
A) 3.79 percent
B) 3.90 percent
C) 3.93 percent
D) 3.95 percent
E) 3.99 percent
Q2) Why would an investor prefer a TIPS which offers a lower coupon rate over a comparable T-note with a higher coupon rate?
Q3) Which one of the following is the feature of a municipal bond that specifies when the bond may be called and the call price?
A) put provision
B) conversion provision
C) close-out clause
D) payment clause
E) call provision
Q4) Explain how the imputed interest is computed on a U. S. Treasury bill.
Q5) What is the advantage of purchasing a STRIPS over a Treasury note?
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Chapter 20: Mortgage-Backed Securities
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Q1) Which one of the following set of mortgage terms will cause the borrower to pay the most interest, assuming the mortgage is paid according to the amortization schedule?
A) 10-year, 6.5 percent
B) 10-year, 7.0 percent
C) 15-year, 7.0 percent
D) 30-year, 6.5 percent
E) 30-year, 7.0 percent
Q2) Which of the following affect the amount of funds available to a homeowner from a reverse mortgage?
I. current mortgage balance on the home
II. age of homeowner
III. location of the home
IV. appraised value of the home
A) I and IV only
B) II and III only
C) I, II, and IV only
D) I, III, and IV only
E) I, II, III, and IV
Q3) How do CMOs increase the availability of mortgage funds?
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