Problem 1. A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?
The annual payments would be larger if the interest rate were lower.
- If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.
- The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.
- The last payment would have a higher proportion of interest than the first payment.
- The proportion of interest versus principal repayment would be the same for each of the 7 payments.
Problem 2. Which of the following statements is CORRECT?
- It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.
- Corporate shareholders are exposed to unlimited liability.
- Corporations generally face fewer regulations than sole proprietorships.
- Corporate shareholders are exposed to unlimited liability, and this factor may be compounded by the tax disadvantages of incorporation.
- There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small.
Problem 3. You recently sold 100 shares of your new company, XYZ Corporation, to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following statements best describes this transaction?
- This is an example of an exchange of physical assets.
- This is an example of a primary market transaction.
- This is an example of a direct transfer of capital.
- This is an example of a money market transaction.
- This is an example of a derivatives market transaction.
Problem 4. How much would $1, growing at 3.5% per year, be worth after 75 years?
Problem 5. Which of the following statements is CORRECT?
- The corporate bylaws are a standard set of rules established by the state of incorporation. These rules are identical for all corporations in the state, and their purpose is to ensure that the firm's managers run the firm in accordance with state laws.
- The corporate charter is a standard document prescribed by the state of incorporation, and its purpose is to ensure that the firm's managers run the firm in accordance with state laws. Procedures for electing corporate directors are contained in bylaws, while the declaration of the activities that the firm will pursue and the number of directors are included in the corporate charter.
- Companies must establish a home office, or domicile, in a particular state, and that state must be the one in which most of their business (sales, manufacturing, and so forth) is conducted.
- Attorney fees are generally involved when a company develops its charter and bylaws, but since these documents are voluntary, a new corporation can avoid these costs by deciding not to have either a charter or bylaws.
- The corporate charter is concerned with things like what business the company will engage in, whereas the bylaws are concerned with things like procedures for electing the board of directors.
Problem 6. Which of the following statements is CORRECT?
- While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.
- A liquid security is a security whose value is derived from the price of some other "underlying" asset.
- Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks.
- Money markets are markets for long-term debt and common stocks.
- The NYSE operates as an auction market, whereas the Nasdaq is a dealer market.
Problem 7. You want to buy a new sports car 3 years from now, and you plan to save $4,200 per year, beginning one year from today. You will deposit your savings in an account that pays 5.2% interest. How much will you have just after you make the 3rd deposit, 3 years from now?
Problem 8. Which of the following investments will have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same.
- Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).
- Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).
- Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).
- Investment D pays $2,500 at the end of 10 years (a total of one payment).
- Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).
Problem 9. Suppose you have $1,500 and plan to purchase a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures?
Problem 10. Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?
- The monthly payments will decline over time.
- A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment.
- The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity.
- The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%.
- Exactly 10% of the first monthly payment represents interest.
Problem 11. Which of the following statements is CORRECT?
- A time line is not meaningful unless all cash flows occur annually.
- Time lines are useful for visualizing complex problems prior to doing actual calculations.
- Time lines cannot be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.
- Time lines can only be constructed for annuities where the payments occur at the ends of the periods, i.e., for ordinary annuities.
- Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
12. Which of the following statements is CORRECT?
- If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction.
- If you purchased 100 shares of Disney stock from your brother-in-law, this would be an example of a primary market transaction.
- The IPO market is a subset of the secondary market.
- Only institutions, and not individuals, can participate in derivatives market transactions.
- As they are generally defined, money market transactions involve debt securities with maturities of less than one year.
Problem 13. Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds. Assuming the announcement was not expected, what effect, other things held constant, would that have on bond prices and interest rates?
- Prices and interest rates would both rise.
- Prices would rise and interest rates would decline.
- Prices and interest rates would both decline.
- There would be no changes in either prices or interest rates.
- Prices would decline and interest rates would rise.
Problem 14. One drawback of switching from a partnership to the corporate form of organization is the following:
- It subjects the firm to additional regulations.
- It cannot affect the amount of the firm's operating income that goes to taxes.
- It makes it more difficult for the firm to raise additional capital.
- It makes the firm's investors subject to greater potential personal liabilities.
- It makes it more difficult for the firm's investors to transfer their ownership interests.
Problem 15. Money markets are markets for
- Foreign stocks.
- Consumer automobile loans.
- U.S. stocks.
- Short-term debt securities.
- Long-term bonds.
Problem 16. Which of the following statements is CORRECT?
- A hostile takeover is the main method of transferring ownership interest in a corporation.
- Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization.
- A corporation is a legal entity that is generally created by a state, and it has a life and existence that is separate from the lives of its individual owners and managers.
- Limited liability of its stockholders is an advantage of the corporate form of organization, but corporations have more trouble raising money in financial markets because of the complexity of this form of organization.
- Although its stockholders are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way, i.e., bondholders can sue its managers if the firm defaults on its debt, even if the default is the result of poor economic conditions.
Problem 17. Last year Mason Corp's earnings per share were $2.50, and its growth rate during the prior 5 years was 9.0% per year. If that growth rate were maintained, how many years would it take for Mason's EPS to double?
Problem 18. Which of the following statements is CORRECT?
- Corporations generally are subject to fewer regulations and more favorable tax treatment than sole proprietorships and partnerships. This is why corporations do most of the business in the United States.
- Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value than are managers who do not face the threat of hostile takeovers.
- One advantage of the corporate form of organization is that liability of the owners of the firm is limited to their investment in the firm.
- Because of their simplified organization, it is easier for sole proprietorships and partnerships to raise large amounts of outside capital than it is for corporations.
- Bond covenants are an effective way to resolve conflicts between shareholders and managers.
Problem 19. Which of the following statements is CORRECT?
- Corporations are at a disadvantage relative to partnerships because they have to file more reports to state and federal agencies, including the Securities and Exchange Administration, even if they are not publicly owned.
- In a regular partnership, liability for the firm's debts is limited to the amount a particular partner has invested in the business.
- A fast-growth company would be more likely to set up as a partnership for its business organization than would a slow-growth company.
- Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership.
- A major disadvantage of a partnership relative to a corporation as a form of business organization is the high cost and practical difficulty of its formation.
20. A Treasury bond promises to pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?
- The periodic interest rate is greater than 3%.
- The periodic rate is less than 3%.
- The present value would be greater if the lump sum were discounted back for more periods.
- The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually.
- The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333. 33 ordinary annuity.