Practice Question Answer Key:

1. A financial intermediary is an entity that collects funds from investors and lends them to
individuals or organizations in need of capital. An example of
this would be a bank that accepts deposits and uses those funds to provide long-term
mortgage loans.
a. True
b. False
2. Today’s financial institutions are much more diverse compared to the past, when federal
laws strictly separated investment banks, commercial
banks, insurance companies, and similar entities. Modern financial services corporations
now offer a broad spectrum of products, from basic
checking accounts and insurance to underwriting securities and providing stock brokerage
services.
a. True
b. False
3. You recently sold 200 shares of Tesla stock through a broker. This would be classified as:
a. A money market transaction
b. A primary market transaction
c. A secondary market transaction
d. A futures market transaction
e. An over-the-counter market transaction
4. If investors expect inflation to be zero, the nominal return on a short-term U.S. Treasury
bond will be equivalent to the real risk-free rate, r*.
a. True
b. False
5. Which of the following statements is CORRECT?
a. The New York Stock Exchange operates as an auction market and has a physical location
b. Home mortgage loans are traded in the money market
c. Selling shares of stock through a broker qualifies as a primary market transaction
d. Capital markets are focused solely on common stocks and other equity securities
e. Although the lines are becoming less clear, investment banks typically focus on lending
money, while commercial banks primarily assist companies in raising
capital from external sources
6. The risk associated with interest rates rising, leading to a decrease in the value of existing
bonds, is referred to as "interest rate risk" or "price risk
a. True
b. False
7. Which of the following factors is most likely to cause an increase in nominal interest rates?
a. Households cut back on spending and boost their savings
b. A new technology, such as the Internet, is introduced, leading to greater investment
opportunities
c. Expected inflation decreases
d. The economy enters a recession
e. The Federal Reserve takes actions to stimulate economic growth
8. Assuming the current corporate bond yield curve is upward sloping, we can confidently
infer that:
a. Inflation is not expected to decrease in the future
b. The economy is likely not experiencing a recession
c. Long-term bonds are not necessarily a better investment than short-term bonds
d. The upward slope of the yield curve may be influenced by maturity risk premiums
e. Long-term interest rates are generally more volatile compared to short-term rates
9. Which of the following statements is most accurate?
a. Retained earnings, as shown on the balance sheet, indicate the cash available for a
company to distribute as dividends to shareholders
b. 70% of the interest income earned by corporations is exempt from taxable income
c. 70% of the dividends received by corporations are excluded from taxable income
d. Investors must pay the highest individual tax rate on long-term capital gains because taxes
are due only when the gain is realized
e. The corporate tax system encourages equity financing, as dividend payments are tax-
deductible for corporations
10. Last year, Tulip Industries reported (1) negative cash flow from operations, (2) negative
free cash flow, and (3) an increase in cash on its balance sheet.
Which of the following factors might account for this scenario?
a. The company experienced a significant rise in its inventory levels
b. The company saw a notable increase in its accrued liabilities
c. The company issued new common stock
d. The company made a substantial capital investment early in the year
e. The company had a large increase in depreciation expenses
11. Mike Row Software's balance sheet indicates total common equity of $5,125,000. The
company has 530,000 shares of stock in circulation, with each
share priced at $27.50. What is the difference between the firm's market value and book
value per share?
a. $17.83
b. $18.72
c. $19.66
d. $20.64
e. $21.67
12. Which of the following, when considered independently, would raise a company's
current ratio?
a. An increase in net fixed assets
b. An increase in accrued liabilities
c. An increase in notes payable
d. An increase in accounts receivable
e. An increase in accounts payable
13. A company aims to improve its financial position. Which of the following actions would
lead to an increase in its current ratio?
a. Reduce the company’s days’ sales outstanding to the industry average, then use the cash
savings to buy plant and equipment
b. Use cash to buy back some of the company’s own shares
c. Take on short-term debt and use the funds to pay off long-term debt
d. Issue new stock, then allocate some of the proceeds to purchase more inventory and keep
the rest in cash
e. Use cash to increase the company’s inventory
14. Companies E and P both reported identical earnings per share (EPS), yet Company E's
stock is priced higher. Which of the following statements is
CORRECT?
a. Company E likely has fewer growth opportunities
b. Company E is probably judged by investors to be riskier
c. Company E must have a higher market-to-book ratio
d. Company E is likely to pay a lower dividend
e. Company E has a higher price-to-earnings (P/E) ratio
15. Petro Gas Company has a current ratio of 2.0. Which of the following actions, if taken
alone, would decrease the current ratio?
a. Borrow using short-term notes payable and use the funds to decrease accruals
b. Borrow using short-term notes payable and use the funds to pay down long-term debt
c. Use cash to reduce accruals
d. Use cash to pay off short-term notes payable
e. Use cash to settle accounts payable
16. Which of the following bonds would see the largest percentage increase in value ifthe
yield to maturity were to decrease by 1%?
a. A 1-year zero-coupon bond
b. A 1-year bond with an 8% coupon rate
c. A 10-year bond with an 8% coupon rate
d. A 10-year bond with a 12% coupon rate
e. A 10-year zero-coupon bond
17. Corporations typically generate returns for their shareholders by acquiring and managing
both tangible and intangible assets. The risk associated with each asset should be assessed
based on how it impacts the overall risk faced by the company's shareholders.
a. True
b. False
18. Which of the following statements best describes the outcome of randomly selecting and
adding stocks to your portfolio?
a. Adding more stocks will decrease the portfolio's unsystematic (or diversifiable) risk
b. Adding more stocks will raise the portfolio's expected return
c. Adding more stocks will lower the portfolio's beta and, in turn, reduce its systematic risk
d. Adding more stocks will not impact the portfolio's overall risk
e. Adding more stocks will decrease the portfolio's market risk but not its unsystematic risk
19. Taylor Furnishings aims to shorten its cash conversion cycle. Which of the following
actions would be most effective?
a. Increase average inventory without boosting sales
b. Take measures to reduce the days sales outstanding (DSO)
c. Start paying bills more quickly, which would lower average accounts payable without
impacting sales
d. Issue common stock to pay off long-term bonds
e. Issue long-term bonds and use the proceeds to repurchase some of its common stock
20. The firm's objective should be:
a. Maximizing profits
b. Maximizing shareholder value
c. Maximizing customer satisfaction
d. Maximizing sales
21. Buying a security from a company that is offering its stock to the public for the first time
would be classified as:
a. a secondary market transaction
b. an initial public offering (IPO)
c. a seasoned new issue
d. Both A and B
22. The existence of a corporation is not influenced by the condition of its investors.
a. True
b. False
23. The average duration that a peso is invested in current assets is referred to as the:
a. net working capital
b. inventory conversion period
c. receivable conversion period
d. cash conversion period
24. In a sole proprietorship, the owner has unlimited personal liability for the debts and
obligations incurred.
a. True
b. False
25. The implementation of safety stock by a company will:
a. decrease inventory costs
b. increase inventory costs
c. have no impact on inventory costs
d. none of the above
26. General partners can transfer ownership freely, while limited partners need approval
from all other partners to transfer their ownership.
a. True
b. False
27. Swift Fashions Inc.'s balance sheet on December 31, 2014, reported total common equity
of $4,050,000, with 200,000 shares outstanding. The company earned $450,000 in net
income during 2014 and distributed $100,000 in dividends. What was the book value per
share on December 31, 2014, assuming no changes in the number of shares issued or
repurchased during the year?
a. $20.90
b. $22.00
c. $23.10
d. $24.26
e. $25.47
28. Which of the following would suggest an enhancement in a company's financial health,
assuming all other factors remain unchanged?
a. Both the inventory and total assets turnover ratios decrease
b. The total debt to total capital ratio rises
c. The profit margin decreases
d. The times-interest-earned ratio decreases
e. Both the current and quick ratios increase
29. The Midnights Corporation has recently acquired a costly piece of equipment. Originally,
the company planned to depreciate the equipment over 5 years using the straight-line
method. However, following a new provision passed by Congress, Nantell is now required to
depreciate the equipment over 7 years using the same method. Assuming other factors
remain unchanged, which of the following outcomes will result from this change? It is
assumed that the company applies the same depreciation method for both tax reporting and
financial reporting purposes.
a. Nantell’s taxable income will decrease
b. Nantell’s operating income (EBIT) will increase
c. Nantell’s cash position will improve
d. Nantell’s reported net income for the year will decrease
e. Nantell’s tax liability for the year will decrease
30. Which of the following would typically suggest an improvement in a company's financial
position, assuming all other factors remain unchanged?
a. The TIE (Times Interest Earned) ratio decreases
b. The DSO (Days Sales Outstanding) increases
c. The quick ratio increases
d. The current ratio decreases
e. The total asset turnover decreases
31. If a bank loan officer is reviewing a company's loan application, which of the following
statements would be considered CORRECT?
a. Other factors being equal, a lower inventory turnover ratio would result in a higher
interest rate charged by the bank
b. All else being equal, a higher Days Sales Outstanding (DSO) ratio would lead to a higher
interest rate from the bank
c. Other things remaining the same, a lower debt-to-capital ratio would likely result in a
lower interest rate from the bank
d. If the company’s Times Interest Earned (TIE) ratio is lower, and other factors remain
unchanged, the bank would charge a higher interest rate
e. All else being equal, a lower current ratio would typically lead to a higher interest rate on
the loan
32. Assume that the interest rates for 20-year Treasury bonds and corporate bonds with
varying ratings, all of which are noncallable, are as follows:
T-bond = 7.72% A= 9.64%
AAA= 8.72% BBB = 10.18%
The variations in these rates are most likely due to:
a. Differences in the real risk-free rate
b. Tax-related effects
c. Default and liquidity risk differences
d. Differences in maturity risk
e. Inflation differences
33. A10-year corporate bond with a 9% annual coupon is currently priced at par ($1,000).
Which of the following statements is CORRECT?
a. The bond's expected capital gains yield is zero
b. The bond's yield to maturity is greater than 9%
c. The bond's current yield is greater than 9%
d. If the bond's yield to maturity decreases, the bond will trade at a discount
e. The bond's current yield is lower than its expected capital gains yield
34. Net working capital is the result of dividing current assets by current liabilities.
a. True
b. False
35. For a portfolio consisting of 40 randomly selected stocks, which of the following is most
likely true?
a. The portfolio’s risk is higher than the risk of each stock when held alone
b. The portfolio’s risk is the same as the risk of each stock when held alone
c. The portfolio’s beta is lower than the weighted average of the individual stock betas
d. The portfolio’s beta is equal to the weighted average of the individual stock betas
e. The portfolio’s beta is higher than the weighted average of the individual stock beta
36. Which of the following statements most accurately describes the focus of finance?
a. The impact of political, social, and economic factors on corporations
b. Maximizing profitability
c. The creation and preservation of economic wealth
d. Mitigating risk
e. Gaining access to capital markets
37. The challenge in identifying profitable projects is primarily due to:
a. Social responsibility
b. Competitive markets
c. Ethical concerns
d. Opportunity costs
e. Rising costs
38. A sole proprietorship is often considered the preferred business structure in most
situations.
a. True
b. False
39. Since the market return represents the expected return on an average stock, it
incorporates a certain level of risk. Consequently, there is a market risk premium, which
represents the additional return above the risk-free rate needed to compensate investors for
taking on this average risk.
a. True
b. False
40. Fearless Company adopts an aggressive financing policy for working capital
management, whereas Red Corporation follows a conservative financing
policy. Which of the following statements is correct?
a. Fearless has a lower proportion of short-term debt to total debt, while Red has a higher
proportion of short-term debt to total debt
b. Fearless has a lower current ratio, while Red has a higher current ratio
c. Fearless faces less liquidity risk, while Red faces more liquidity risk
d. Fearless uses long-term debt to finance short-term assets, while Red uses short-term debt
to finance short-term assets

Additional Reviewer:
1. Which of the following statements is CORRECT?
a. If you purchase 100 shares of Disney stock from your brother-in-law, this is an example
of a primary market transaction.
b. If Disney issues additional shares of common stock through an investment banker, this
would be a secondary market transaction.
c. The NYSE is an example of an over-the-counter market.
d. Only institutions, and not individuals, can engage in derivative market transactions.
e. As they are generally defined, money market transactions involve debt securities with
maturities of less than one year.

2. Assume that inflation is expected to decline steadily in the future, but that the real risk-
free rate, r*, will remain constant. Which of the following statements is CORRECT, other
things held constant?
a. If the pure expectations theory holds, the Treasury yield curve must be downward
sloping.
b. If the pure expectations theory holds, the corporate yield curve must be downward
sloping.
c. If there is a positive maturity risk premium, the Treasury yield curve must be upward
sloping.
d. If inflation is expected to decline, there can be no maturity risk premium.
e. The expectations theory cannot hold if inflation is decreasing

3. Which of the following statements is CORRECT?

a. If the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve
must be upward sloping.
b. If the maturity risk premium (MRP) equals zero, the Treasury bond yield curve must be
flat.
c. If inflation is expected to increase in the future and the maturity risk premium (MRP) is
greater than zero, the Treasury bond yield curve must be upward sloping.
d. If the expectations theory holds, the Treasury bond yield curve will never be downward
sloping.
e. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury
bonds will always be higher than yields on short-term T-bonds.

4. Which of the following statements is CORRECT?

a. The higher the maturity risk premium, the higher the probability that the yield curve will
be inverted.
b. The most likely explanation for an inverted yield curve is that investors expect inflation
to increase.
c. The most likely explanation for an inverted yield curve is that investors expect inflation
to decrease.
d. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
e. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the
corporate yield curve can never be inverted.
5. Which of the following statements is most correct?
a. Retained earnings, as reported on the balance sheet, represents the amount of cash a
company has available to pay out as dividends to shareholders.
b. 70% of the interest received by corporations is excluded from taxable income.
c. 70% of the dividends received by corporations is excluded from taxable income.
d. Because taxes on long-term capital gains are not paid until the gain is realized, investors
must pay the top individual tax rate on that gain.
e. The corporate tax system favors equity financing, as dividends paid are deductible from
corporate taxes.

6. Assume that Besley Golf Equipment commenced operations on January 1, 2014, and it
was granted permission to use the same depreciation calculations for shareholder reporting
and income tax purposes. The company planned to depreciate its fixed assets over 15 years,
but in December 2014 management realized that the assets would last for only 10 years. The
firm's accountants plan to report the 2014 financial statements based on this new
information. How would the new depreciation assumption affect the company's financial
statements?
a. The firm's reported net fixed assets would increase.
b. The firm's EBIT would increase.
c. The firm's reported 2014 earnings per share would increase.
d. The firm's cash position in 2014 and 2015 would increase.
e. The provision will increase the company's tax payments

7. The CFO of Daves Industries plans to have the company issue $300 million of new
common stock and use the proceeds to pay off some of its outstanding bonds that carry a
7% interest rate. Assume that the company, which does not pay any dividends, takes this
action, and that total assets, operating income (EBIT), and its tax rate all remain constant.
Which of the following would occur?
a. The company's taxable income would fall.
b. The company's interest expense would remain constant.
c. The company would have less common equity than before.
d. The company's net income would increase.
e. The company would have to pay less taxes.

8. Which of the following statements is CORRECT?

a. A reduction in inventories would have no effect on the current ratio.
b. An increase in inventories would have no effect on the current ratio.
c. If a firm increases its sales while holding its inventories constant, then, other things held
constant, its inventory turnover ratio will increase.
d. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
e. If a firm increases its sales while holding its inventories constant, then, other things held
constant, its fixed assets turnover ratio will decline.

9. Under normal conditions, which of the following would be most likely to increase the
coupon rate required for a bond to be issued at par?
a. Adding additional restrictive covenants that limit management's actions.
b. Adding a call provision.
c. The rating agencies change the bond's rating from Baa to Aaa.
d. Making the bond a first mortgage bond rather than a debenture.
e. Adding a sinking fund.
10. If a bank loan officer were considering a company's loan request, which of the following
statements would you consider to be CORRECT?
a. The lower the company's inventory turnover ratio, other things held constant, the lower
the interest rate the bank would charge the firm.
b. Other things held constant, the higher the days sales outstanding ratio, the lower the
interest rate the bank would charge.
c. Other things held constant, the lower the total debt to total capital ratio, the lower the
interest rate the bank would charge.
d. The lower the company's TIE ratio, other things held constant, the lower the interest rate
the bank would charge.
e. Other things held constant, the lower the current ratio, the lower the interest rate the
bank would charge the firm.

11. A 15-year bond with a face value of $1,000 currently sells for $850. Which of the
following statements is CORRECT?
a. The bond's coupon rate exceeds its current yield.
b. The bond's current yield exceeds its yield to maturity.
c. The bond's yield to maturity is greater than its coupon rate.
d. The bond's current yield is equal to its coupon rate.
e. If the yield to maturity stays constant until the bond matures, the bond's price will remain
at $850.

12. Helena Furnishings wants to reduce its cash conversion cycle. Which of the following
actions should it take?
a. Increases average inventory without increasing sales.
b. Take steps to reduce the DSO.
c. Start paying its bills sooner, which would reduce the average accounts payable but not
affect sales.
d. Sell common stock to retire long-term bonds.
e. Sell an issue of long-term bonds and use the proceeds to buy back some of its common
stock.

13. Zap company follows an aggressive financing policy in its working capital management
while Zing Corporation follows a conservative financing policy. Which one of the following
statements is correct?
a. Zap has low ration of short-term debt to total debt while Zing has a high ratio of short-
term debt to total debt
b. Zap has a low current ratio while Zing has a high current ratio
c. Zap has less liquidity risk while Zing has more liquidity risk
d. Zap finances short-term assets with long-term debt while Zing finances short-term assets
with short-term debt.

14. All but which of the following is considered in determining credit policy?
a. credit standards
b. credit limits
c. accounts payable deferral period
d. collection efforts

15. In a general partnership, each partner is liable for the partnership’s obligations only up
to a percentage of the obligation equal to that partner’s percentage of ownership of the
partnership.
a. True
b. False