Principles of Finance Exam Review
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools used in financial decision-making within organizations. The course covers key topics such as the time value of money, risk and return, financial statement analysis, valuation of stocks and bonds, and the basics of capital budgeting. Through the study of these principles, students gain a foundational understanding of the role and functioning of financial markets, the financial system, and the factors influencing an organizations financial policies and strategies. The course equips students with the analytical and quantitative skills necessary to assess financial options and make informed business decisions.
Recommended Textbook
Financial Markets and Institutions 12th Edition by Jeff Madura
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26 Chapters
1664 Verified Questions
1664 Flashcards
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Page 2
Chapter 1: Role of Financial Markets and Institutions
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Sample Questions
Q1) The total asset value of savings institutions is larger than that of commercial banks.
A)True
B)False
Answer: False
Q2) Funds are provided to the initial issuer of securities in the
A) secondary market.
B) primary market.
C) deficit market.
D) surplus market.
Answer: B
Q3) Money market securities are commonly issued to finance the purchase of assets such as buildings, equipment, or machinery.
A)True
B)False
Answer: False
Q4) Debt securities represent debt (borrowed funds) incurred by the issuer.
A)True
B)False
Answer: True
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Chapter 2: Determination of Interest Rates
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Sample Questions
Q1) The ____ sector is the largest supplier of loanable funds.
A) household
B) government
C) business
D) none of the above
Answer: A
Q2) If foreign interest rates fall, foreign firms and governments would likely reduce their demand for U.S. funds.
A)True
B)False
Answer: True
Q3) If inflation is expected to decrease, then
A) savers will provide less funds at the existing equilibrium interest rate.
B) the equilibrium interest rate will increase.
C) the equilibrium interest rate will decrease.
D) borrowers will demand more funds at the existing equilibrium interest rate.
Answer: C
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Page 4
Chapter 3: Structure of Interest Rates
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Sample Questions
Q1) Within the category of capital market securities, municipal bonds have the before-tax yield, and their after-tax yield is typically of Treasury bonds from the perspective of investors in high tax brackets. A) highest; below that B) lowest; above that C) highest; above that D) lowest; below that
Answer: B
Q2) The yield curve in a foreign country is A) always downward sloping.
B) nonexistent.
C) the same as the United States at any point in time.
D) none of the above
Answer: D
Q3) The term structure of interest rates defines the relationship A) between risk and return. B) between risk and maturity.
C) between maturity and yield.
D) between default risk ratings and maturity.
Answer: C
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Chapter 4: Functions of the Fed
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Sample Questions
Q1) When the Fed buys Treasury bills as a means of increasing the money supply, it places ____ pressure on their prices and ____ pressure on their yields.
A) upward; upward
B) downward; downward
C) upward; downward
D) downward; upward
Q2) The ____ rate is the interest rate charged on the Fed's short-term loans to depository institutions.
A) federal funds
B) prime
C) primary credit lending
D) real
Q3) To increase the money supply, the Fed may increase the reserve requirement ratio.
A)True
B)False
Q4) All commercial banks are required to be members of the Fed.
A)True
B)False
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Chapter 5: Monetary Policy
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Sample Questions
Q1) Which of the following was not true of the eurozone during the Greek crisis?
A) Fear of a financial crisis throughout Europe discouraged investors and firms from moving funds into Europe.
B) By using a more stimulative monetary policy than it desired, the European Central Bank aroused concerns about potential inflation in the eurozone.
C) There was concern that the austerity conditions could weaken the country's economy further.
D) Greece, Spain, and Portugal focused their efforts on reducing tax rates in order to stimulate their economies.
Q2) If the Fed uses a passive monetary policy during weak economic conditions,
A) it increases the money supply substantially.
B) it reduces the money supply substantially.
C) it allows the economy to fix itself.
D) it purchases commercial paper and mortgage-backed securities.
Q3) The Fed is more likely to use a stimulative policy during a strong-dollar period.
A)True B)False
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Chapter 6: Money Markets
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Sample Questions
Q1) Which of the following is true of money market instruments?
A) Their yields are highly correlated over time.
B) They typically sell for par value when they are initially issued (especially T-bills and commercial paper).
C) Treasury bills have the highest yield.
D) They all make periodic coupon (interest) payments.
E) A and B
Q2) You purchase a six-month (182-day) T-bill with a $10,000 par value for $9,800. The Treasury bill discount is ____ percent.
A) 3.96
B) 4.09
C) 6.2
D) 3.56
E) none of the above
Q3) Exporters can hold a banker's acceptance until the date at which payment is to be made, but they frequently sell the acceptance before then at a discount to obtain cash immediately.
A)True
B)False
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Page 8
Chapter 7: Bond Markets
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Sample Questions
Q1) The bond debenture is a legal document specifying the rights and obligations of both the issuing firm and the bondholders.
A)True
B)False
Q2) ____ bonds have the most active secondary market.
A) Treasury
B) Zero-coupon corporate
C) Junk
D) Municipal
Q3) ____ bids for Treasury bonds specify a price that the bidder is willing to pay and a dollar amount of securities to be purchased.
A) Competitive
B) Noncompetitive
C) Negotiable
D) Non-negotiable
Q4) Subordinated indentures have claims against the firm's assets that are junior to the claims of both mortgage bonds and regular debentures.
A)True
B)False
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Chapter 8: Bond Valuation and Risk
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Sample Questions
Q1) He appropriate discount rate for valuing any bond is the A) bond's coupon rate.
B) bond's coupon rate adjusted for the expected inflation rate over the life of the bond.
C) Treasury bill rate with an adjustment to include a risk premium if one exists.
D) yield that could be earned on alternative investments with similar risk and maturity.
Q2) Foreign investors anticipating dollar depreciation are less willing to hold U.S. bonds because the coupon payments will convert to less of their home currency.
A)True
B)False
Q3) Any announcement that signals stronger than expected economic growth tends to increase bond prices.
A)True
B)False
Q4) Duration is a measure of the life of a bond on a present value basis.
A)True
B)False
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Page 10
Chapter 9: Mortgage Markets
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Sample Questions
Q1) The interest rate on a second mortgage is ____ on a first mortgage created at the same time, because the second mortgage is ____ the existing first mortgage in priority claim against the propertyin the event of default.
A) higher than; behind B) equal to that; equal to C) lower than; ahead of D) higher than; ahead of E) lower than; behind
Q2) A __________ is a privately negotiated contract that protects investors against the risk of default on particular debt securities such as mortgage-backed securities.
A) default insurance contract
B) default risk swap
C) credit default swap
D) collateralized debt obligation
Q3) Speculators sell credit default swaps to benefit from the default of specific subprime mortgages.
A)True
B)False
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Chapter 10: Stock Offerings and Investor Monitoring
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Sample Questions
Q1) Common law countries such as the United States, Canada, and the United Kingdom allow for more legal protections for shareholders than civil law countries such as France or Italy.
A)True
B)False
Q2) If many investors quickly sell an IPO stock in the secondary market, there will be ____ on the stock's price.
A) upward pressure
B) downward pressure
C) no additional pressure
D) none of the above
Q3) Whenever _____, the stock price will be driven up.
A) supply exceeds demand
B) demand exceeds supply
C) demand is reduced
D) none of the above
Q4) The total cost of engaging in an IPO is usually about 1 percent of the total proceeds.
A)True
B)False
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Chapter 11: Stock Valuation and Risk
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Sample Questions
Q1) The January effect refers to the ____ pressure on ____ stocks in January of every year.
A) downward; large
B) upward; large
C) downward; small
D) upward; small
Q2) A stock's average return is 10 percent. The average risk-free rate is 7 percent. The standard deviation of the stock's return is 4 percent, and the stock's beta is 1.5. What is the Treynor indexfor the stock?
A) 0.03
B) 0.75
C) 1.33
D) 0.02
E) 50
Q3) The ____ is not a measure of a stock's risk.
A) stock's price volatility
B) stock's return
C) stock's beta
D) value-at-risk method
E) All of the above are measures of a stock's risk.
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Chapter 12: Market Microstructure and Strategies
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Sample Questions
Q1) ______________ represents the use of electronic platforms to execute orders based on an algorithm with programmed instructions.
A) High frequency trading
B) Mechanical analysis
C) Liquidity trading
D) Technical analysis
Q2) When the price of a company's stock increases or decreases significantly in advance of a public announcement of an event affecting the company, there are suspicions that __________ may have occurred.
A) bid rigging
B) default inversion
C) insider trading
D) an increase in margin requirements
Q3) The short interest ratio is commonly measured as the number of shares sold short divided by the number of shares that the firm has repurchased in the last quarter.
A)True
B)False
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Chapter 13: Financial Futures Markets
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60 Flashcards
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Sample Questions
Q1) Trading restrictions imposed on specific stocks or stock indexes are referred to as A) index busters.
B) index options.
C) circuit breakers.
D) protective covenants.
Q2) According to the text, using a futures contract on one financial instrument to hedge a position in a different financial instrument is known as A) cross-hedging.
B) ratio hedging.
C) basis hedging.
D) liquid hedging.
Q3) The net gain or loss on a futures contract for a stock index that is not closed out is the difference between the futures price when the initial position was created and the futures price at
A) the settlement date.
B) the date at which the futures price reaches its maximum.
C) the date at which the futures price reaches its minimum.
D) the date three months beyond the date when the initial position was taken.
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15
Chapter 14: Options Markets
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Sample Questions
Q1) American-style stock options can be exercised only just before expiration.
A)True
B)False
Q2) Which of the following can normally be found in quotations for stock options provided by the financial media?
A) exercise price, expiration date, and implied volatility
B) exercise price, expiration date, and most recently quoted premium
C) expiration date, implied volatility, and trading volume
D) expiration date, most recently quoted premium, and implied volatility
Q3) The premium on an existing put option should ____ when there is a reduction in the expected short-term volatility of the stock price.
A) be negative
B) decline
C) increase
D) be unaffected
E) A and B
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Chapter 15: Swap Markets
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Sample Questions
Q1) ____ swap allows the party making fixed-rate payments to terminate the swap prior to maturity.
A) forward
B) extendable
C) callable
D) putable
Q2) Lizard National Bank purchases a three-year interest rate cap for a fee of 2 percent of notional principal valued at $50 million, with an interest rate ceiling of 11 percent and LIBOR as theindex representing the market interest rate. LIBOR is 9 percent, 12 percent, and 13 percent at the end of each of the next three years, respectively. The total payments received (or paid) by Lizard, including the initial fee, are $____.
A) 500,000
B) -500,000
C) -1,500,000
D) 1,500,000
E) none of the above
Q3) Interest rate floors are commonly used to hedge against lower interest rates.
A)True
B)False
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Page 17
Chapter 16: Foreign Exchange Derivative Markets
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Sample Questions
Q1) Generally, a ____ home currency can ____ domestic economic growth.
A) weak; dampen
B) strong; stimulate
C) strong; dampen
D) A and B
Q2) The potential benefits from using foreign exchange derivatives are independent of the expected exchange rate movements.
A)True
B)False
Q3) ____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers.
A) Pension funds
B) International mutual funds
C) Insurance companies
D) Commercial banks
E) None of the above
Q4) Financial institutions rarely use the forward market.
A)True
B)False
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Chapter 17: Commercial Bank Operations
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Sample Questions
Q1) Protective covenants impose conditions that require the bank to provide additional loans to a borrower to protect the borrower from going bankrupt.
A)True
B)False
Q2) The bank holding company structure allows more flexibility to borrow funds, issue stock, repurchase the company's own stock, and acquire other firms.
A)True
B)False
Q3) States may enact _______ to set a maximum on the rate of interest that banks can charge.
A) leveraged loan laws
B) credit protection laws
C) consumer interest laws
D) usury laws
Q4) A bank's sources of funds represent liabilities or equity of the bank.
A)True
B)False
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Chapter 18: Bank Regulation
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Sample Questions
Q1) In making loans to a single customer, commercial banks ____ restricted to a maximum percentage of their capital, and they ____ allowed to use borrowed or deposited funds to purchase common stock.
A) are; are
B) are; are not
C) are not; are
D) are not; are not
Q2) Which banking act allowed banks to cross state lines in order to acquire a failing institution?
A) McFadden Act
B) Glass-Steagall Act
C) DIDMCA
D) Garn-St Germain Act
Q3) A bank can increase its capital ratio by:
A) buying back shares of its stock from shareholders.
B) selling assets.
C) increasing its dividend to encourage more investors to purchase its stock.
D) increasing its off-balance sheet activities.
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Page 20
Chapter 19: Bank Management
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Sample Questions
Q1) Assume a bank accepts deposits in Australian dollars (A$) and makes some fixed-rate loans in British pounds. Which of the following would reduce the bank's profit margin?
A) The A$ appreciates against the pound.
B) The A$ is stable against the pound.
C) The A$ depreciates against the pound.
D) British interest rates increase.
E) C and D
Q2) Banks generally ____ loans and ____ their purchases of low-risk securities when the economy is weak.
A) increase; increase
B) reduce; reduce
C) increase; reduce
D) reduce; increase
Q3) A positive gap (or gap ratio of more than 1.00) suggests that rate-sensitive liabilities exceed rate-sensitive assets.
A)True
B)False
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Chapter 20: Bank Performance
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Sample Questions
Q1) During the credit crisis, the level of ____ was much higher than in other periods. A) interest income
B) income expenses
C) noninterest expenses
D) loan loss provisions
Q2) If a bank has long-term fixed-rate assets and short-term liabilities, and interest rates increase over time, its net interest margin should A) decrease
B) increase
C) stay the same.
D) either A or B, depending on whether the asset maturities exceed 10 years
Q3) A bank's ROE ____ account for its financial leverage. A bank's ROA ____ account for its financial leverage. A) does; does
B) does; does not
C) does not; does not
D) does not; does
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Chapter 21: Thrift Operations
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Sample Questions
Q1) Credit unions obtain most of their funds by borrowing from the U.S. government.
A)True
B)False
Q2) To obtain short-term funds, savings institutions commonly borrow funds in the ____ market.
A) stock
B) bond
C) mortgage
D) federal funds
E) futures
Q3) Because credit unions do not issue stock, they are technically sole proprietorships.
A)True
B)False
Q4) To measure ____ risk, some savings institutions measure the duration of their respective assets and liabilities.
A) credit
B) interest rate
C) liquidity
D) none of the above
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Chapter 22: Finance Company Operations
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Sample Questions
Q1) When interest rates increase, finance companies tend to use more long-term debt to lock in their cost of funds over an extended period of time.
A)True
B)False
Q2) The most important risk for finance companies is ____ risk.
A) settlement
B) accounting
C) credit
D) exchange rate
Q3) Which of the following is not a use of finance company funds?
A) consumer loans
B) business loans
C) commercial paper
D) real estate loans
E) All of the above are uses of finance company funds.
Q4) Consumer finance companies sometimes provide mortgage loans to individuals.
A)True
B)False
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Page 24
Chapter 23: Mutual Fund Operations
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Sample Questions
Q1) Which of the following is not a way in which mutual funds generate returns for their shareholders?
A) They can pass on any earned income as dividend payments to shareholders.
B) They distribute the capital gains resulting from the sale of securities within the fund.
C) The mutual fund price appreciates.
D) All of the above are ways in which a mutual fund generates returns to its shareholders.
Q2) Funds that are designed to mimic particular stock indexes and are traded on a stock exchange are known as
A) index mutual funds.
B) exchange-traded funds.
C) money market funds.
D) none of the above
Q3) Money market funds commonly invest in A) stocks.
B) real estate.
C) commercial paper.
D) U.S. Treasury bonds.
E) none of the above
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Page 25
Chapter 24: Securities Operations
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Sample Questions
Q1) When an IPO is planned, all information relevant to the security, as well as the agreement between the issuer and the securities firm, must be included in the ___________ that is submitted totheSecurities and Exchange Commission.
A) origination
B) registration statement
C) best-efforts agreement
D) none of the above
Q2) Securities firms commonly engage in all of the following functions except
A) proprietary trading.
B) underwriting stock.
C) operating mutual funds.
D) providing brokerage services.
E) operating credit unions.
Q3) Which of the following is not a way that a securities firm might advise a corporation to restructure its operations?
A) a stock pass-through
B) a spin-off of a unit
C) a carve-out
D) divestiture
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Page 26
Chapter 25: Insurance Operations
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Sample Questions
Q1) Individuals who are insured under a managed health care plan can usually choose any provider of health care services.
A)True
B)False
Q2) ____ effectively reallocates a portion of an insurance company's return and risk to other insurance companies.
A) Reinsurance
B) Cash flow underwriting
C) Factor insurance
D) Universal insurance
Q3) With a(n) ____ insurance policy, the benefits awarded by the life insurance company to the beneficiary differ, depending on the assets backing the policy.
A) universal life
B) whole life
C) variable life
D) group life
E) none of the above
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Chapter 26: Pension Fund Operations
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Q1) A pension plan that provides benefits that are determined by the accumulated contributions and return on the fund's investment performance is called a ____ plan.
A) defined-benefit
B) defined-contribution
C) beneficiary
D) guarantor-insured
Q2) In recent years, defined-contribution plans have commonly been replaced by defined-benefit plans.
A)True
B)False
Q3) To reduce interest rate risk, pension fund managers can
A) shift from variable-rate to fixed-rate bonds.
B) increase the average maturity on fixed-rate bonds.
C) sell bond futures contracts.
D) reduce the investment in money market securities.
Q4) The composition of the stocks in a pension fund's portfolio is determined by the fund's portfolio managers.
A)True
B)False
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