CIS September 2013 Exam Diet
Examination Paper 1.2:
Corporate Finance
Equity Valuation and Analysis
Fixed Income Valuation and Analysis
Level 1
MULTI CHOICE QUESTIONS
Corporate Finance (1 - 33)
1.
What is the discount rate (interest rate) per year if the one year discount factor is
0.8333?
A. 10%
B. 20%
C. 30%
D. None of the above.
2.
A(n) ____________ occurs when there is an increase in the number of shares
outstanding by reducing the par value of stock.
A. Stock split.
B. Stock dividend.
C. Extra dividend.
D. Regular dividend.
3.
What is the NPV of the project if the present value of a cash flow generated by an
initial investment of N100,000 is N120,000?
A. N120,000
B. N20,000
C. N100,000
D. None of the above.
4.
The opportunity cost of capital for a risky project is _________
A. The expected rate of return on a government security having the same
maturity as the project.
B. The expected rate of return on a well diversified portfolio of common stocks.
C. The expected rate of return on a portfolio of securities of similar risks as the
project.
D. None of the above.
5.
Generally, a company is owned by __________
A. Managers.
B. Board of Directors.
C. Shareholders.
D. All of the above.
6.
Modigiliani and Miller argue that the dividend decision ___________
A. Is irrelevant as the value of the firm is based on the earning power of its
assets.
B. Is relevant as the value of the firm is not based just on the earning power of
its assets.
C. Is irrelevant as dividends represent cash leaving the firm to shareholders,
who own the firm anyway.
D. Is relevant as cash outflow always influences other firm decisions.
What is the financial goal of a company?
A. Maximize sales.
B. Maximize profits.
C. Maximize the value of the firm to the shareholders.
D. Maximize managers’ benefits.
7.
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8.
What is “agency costs”?
A. Costs incurred resulting in conflicts of interest between the shareholders and
the managers of a corporation.
B. Costs of monitoring the managers’ actions.
C. (A) and (B) above.
D. None of the above.
9.
Financial institutions facilitate individuals and firms in __________
A. Borrowing.
B. Lending.
C. Pooling of risks.
D. All of the above.
10. A profitability index (PI) of 0.92 for a project means that _____________
A. The project’s costs (cash outlay) are/is less than the present value of the
project’s benefits.
B. The project’s NPV is greater than zero.
C. The project’s NPV is greater than 1.
D. The project returns 92 kobo in present value for each current Naira invested
(cost).
11. An
A.
B.
C.
D.
annuity is defined as __________
Equal cash flows at equal intervals of time forever.
Equal cash flows at equal intervals of time for a specific period.
Unequal cash flows at equal intervals of time forever.
None of the above.
12. Which of the following statements is correct regarding the internal rate of return
(IRR) method?
A. Each project has a unique internal rate of return.
B. As long as you are not dealing with mutually exclusive projects, capital
rationing or unusual projects having multiple sign changes in the cash-flow
stream, the internal rate of return method can be used with reasonable
confidence.
C. The internal rate of return does not consider the time value of money.
D. The internal rate of return is rarely used by firms today because of the ease
at which net present value is calculated.
13. The value of a stock ___________
A. Increases as the dividend growth rate increases.
B. Increases as the required rate of return decreases.
C. Increases as the required rate of return increases.
D. (A) and (B) above.
14. Company B is a normal-growth company that expects to earn 13% on reinvested
earnings. If the company pays 30% of its earnings as dividends, what will be the
stock’s dividend growth rate?
A. 39.0%
B. 17.0%
C. 3.9%
D. 9.1%
15. A company that has more than half of its voting shares owned by another
company is generally referred to as a ____________ of the other firm.
A. Joint-venture partner.
B. Proxy.
C. Subsidiary.
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D. Division.
16. You are given a job to make a decision on project X, which is composed of three
projects A, B and C which have NPVs of +N50, -N20 and +N100, respectively.
How would you go about making the decision about whether to accept or reject
the project?
A. Accept the firm’s joint project as it has a positive NPV.
B. Reject the joint project.
C. Break up the project into its components: accept A and C, and reject B.
D. None of the above.
17. Which of the following is (are) the disadvantages of the Accounting rate of Return
method?
I. It uses net income instead of cash flows.
II. The pattern of income has no impact on the book rate of return.
III. There is no clear-cut decision rule.
A.
B.
C.
D.
I and II only.
I and III only.
II and III only.
All of the above.
18. IRR is defined as ___________
A. The discount rate that makes the NPV equal to zero.
B. The difference between the cost of capital and the net present value of the
cash flows.
C. The discount rate used in the NPV method.
D. The discount rate used in the discounted payable period method.
19. Money that a firm has already spent or committed to spend regardless of
whether to go ahead with a project or not is referred to as __________
A. Sunk costs.
B. Opportunity costs.
C. Fixed costs.
D. None of the above.
20. A firm owns a building with a book value of N100,000 and a market value of
N250,000. If the building is utilized for a project, what is the opportunity cost
(ignoring taxes)?
A. N100,000
B. N150,000
C. N250,000
D. N350,000
21. Higher operating leverage is related to the use of additional ____________
A. Fixed costs.
B. Variable costs.
C. Debt financing.
D. Equity financing.
22. The following projects have NPVs and project lives as detailed below:
Project
Project A
Project B
NPV
N5,000
N7,000
Life
4 years
7 Years
If the cost of capital is 12%, which project would you accept?
A. Project A.
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B. Project B.
C. (A) and (B) above.
D. None of the above.
23. If a corporate security can be exchanged for a fixed number of shares, the
security
is said to be ____________
A. Callable.
B. Convertible.
C. Protected.
D. Putable.
24. Priest Plc is one of the companies in the information technology sectors of the
Nigerian economy. The following data were extracted from its books:
N'000
Market value of equity
3,000
Market value of debt
560
Cost of debt
5%
Cost of equity
15%
Ignoring taxation, what is the weighted average cost of capital (WACC)?
A. 14.50%
B. 13.20%
C. 13.43%
D. 14.344%
25. Warrants are sometimes issued ___________
A.
With private placement bonds.
B.
To investment bankers as compensation.
C.
To creditors in the event of bankruptcy.
D.
All of the above.
26. The beta of a risk-free portfolio is __________
A. 0
B. +0.5
C. +1.0
D. -1.0
27. Minimizing the weighted average cost of capital is the same as ___________
A. Maximizing the market value of the firm.
B. Maximizing the market value of the firm only if MM’s Proposition I holds.
C. Maximizing the profits of the firm.
D. Minimizing the market value.
28. What is market risk premium?
A. The difference between the rate of return on an asset and the risk-free rate.
B. The difference between the rate of return on the market portfolio and the
risk-free rate.
C. The risk-free rate.
D. The market rate of return.
29. Which of the following would result in external capital rationing?
A. A firm’s decision to restrict borrowing in order to avoid dilution of ownership.
B. Economic downturn resulting in credit crunch.
C. Federal Government’s policy of quantitative easing.
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D. A firm’s strategy to grow organically by ploughing back earnings.
30. The security market line (SML) is the graph of ___________
A. Expected rate of return on investment vs. variance of return.
B. Expected rate of return on investment vs. standard deviation of return.
C. Expected rate of return on investment vs. beta.
D. (A) and (B) above.
31. What is the drawback of CAPM? It ___________
A. Ignores the return on the market portfolio.
B. Required a single measure of systematic risk.
C. Ignores risk-free return.
D. Utilizes too many factors.
32. Pristine Ltd has 1,000,000 shares outstanding. It wishes to issue 250,000 new
shares using rights issue. How many rights are needed to buy one new share?
A. 1 right/share.
B. 2 rights/share.
C. 3 rights/share.
D. 4 rights/share.
33. When a company sells an entire issue of securities to a small group of
institutional investors like life insurance, companies, pension funds, e.t.c., it is
called ___________
A. A rights offering.
B. A general art offering.
C. A private placement.
D. An unseasoned issue.
Equity Valuation and Analysis (34 - 67)
34. Holding all else equal, a company’s P/E ratio increases if ____________
A. Risk increases.
B. Growth opportunities increase.
C. Current year EPS increases.
D. Capitalization rate increases.
35. Which of the following is not a commonly used ratio for comparative valuation?
A. Price to debt ratio.
B. Price to book ratio.
C. Price to retained earnings ratio.
D. Price to cash flow ratio.
36. The present value of free cash flow is N5 million and the present value of the
horizon value is N10 million. What is the present value of the business?
A. N5 million.
B. N10 million.
C. N15 million.
D. None of the above.
37. Capital structure of a firm can be defined as ___________
A. The firm’s mix of different securities.
B. The firm’s debt-equity ratio.
C. The market imperfection that the firm’s manager can exploit.
D. All of the above.
38. Which of the following is a problem with attempting to forecast stock values?
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A.
B.
C.
D.
There are no variables that seem to predict market return.
The earnings multiplier approach can only be used at the firm level.
Dividend payout ratios are highly variable.
The level of uncertainty surrounding the forecast will always be quite high.
39. The beta of an all-equity firm is 1.2. If the firm changes its capital structure to
50% debt and 50% equity, what will be the beta of the levered firm? (Assume no
taxes)
A. 1.2
B. 2.4
C. 2.2
D. None of the above.
40. What is the goal of fundamental analysts? To find securities _________
A. With high market capitalization rates.
B. With a positive present value of growth opportunities.
C. Whose intrinsic value exceeds market price.
D. All of the above.
41. Many stock analysts assume that a mispriced stock will ___________
A. Immediately return to its intrinsic value.
B. Never return to its intrinsic value.
C. Return to its intrinsic value within a few days.
D. None of the above.
42. Assuming everything else remains the same, when a stock goes ex-rights its
price should ___________
A. Increase.
B. Decrease.
C. Remain the same.
D. Impossible to predict.
43. What is the model called that determines the present value of a stock based on
its next annual dividend, the dividend growth rate and the applicable discount
rate?
A. Zero growth.
B. Dividend growth.
C. Capital pricing.
D. Earnings capitalization.
44. The Boaz Co. has an equity cost of capital of 17%. The debt to equity ratio is 1.5
and a cost of debt is 11%. What is the cost of equity if the firm was unlevered?
(Assume a tax rate of 33%)
A. 3.06%
B. 14.0%
C. 16.97%
D. None of the above.
45. You cannot attend a shareholder’s meeting for Jingo & Co., so you authorize
another shareholder to vote on your behalf. What is the granting of this authority
called?
A. Altering.
B. Cumulative voting.
C. Straight voting.
D. Voting by proxy.
46. What are the distributions to shareholders by a company called?
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A.
B.
C.
D.
Retained earnings.
Net income.
Dividends.
Capital payments.
47. Which of the following is a type of equity security that has a fixed dividend and a
priority status over other equity securities?
A. Senior bond.
B. Debenture.
C. Warrant.
D. Preferred stock.
48. Jodaq Limited’s stock is listed on the Nigerian Stock Exchange. The firm is
planning to issue some new equity shares for sale to the general public. This sale
will occur in which of the following markets?
A. Private.
B. Exchange floor.
C. Secondary.
D. Primary.
49. Which of the following statements about stock market index is not correct?
A. Fundamental Analysts use the stock index data to derive the intrinsic value of
stocks.
B. It is used as a measure of performance of the market as a whole.
C. Investment analysts find it a useful tool in determining the factors underlying
stock price movement.
D. Stock indexes are very useful in portfolio management.
50. A speculator who believes that the price of a particular security will fall is called a
____________
A. Bear.
B. Bull.
C. Speculator.
D. Trader.
51. Foods Ltd ordinary shares are currently selling for N32.35. The last annual
dividend paid was N1.10 per share and the market rate of return is 10.7 percent.
At what rate is the dividend growing?
A. 7.06 percent.
B. 8.67 percent.
C. 10.42 percent.
D. 12.60 percent.
52. Julie owns shares of Deltona Productions preferred stock which she says provides
her with a constant 14.3 percent rate of return. The stock is currently priced at
N45.45 a share. What is the amount of the dividend per share?
A. N6.00
B. N6.25
C. N6.50
D. N6.60
53. Zylo Company preferred stock pays a N7.50 annual dividend. What is the
maximum price you are willing to pay for one share of this stock today if your
required return is 9.75 percent?
A. N32.26
B. N35.48
C. N72.68
D. N76.92
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54. The next dividend payment by Hillside Markets will be N2.35 per share. The
dividends are anticipated to maintain a 4.5 percent growth rate forever. The stock
currently sells for N70 per share. What is the dividend yield?
A. 3.20 percent.
B. 3.36 percent.
C. 3.54 percent.
D. 4.50 percent.
55. _____________ is an equation describing the expected return on an asset (or
portfolio) as a linear function of its beta relative to the market portfolio.
A. Capital market line (CML).
B. Capital rationing (CR).
C. Capital asset pricing model (CAPM).
D. Capital allocation line (CAL).
56. Which one of the following rights is never directly granted to all shareholders of a
publicly-held corporation?
A. Electing the Board of Directors.
B. Receiving a distribution of company profits.
C. Voting either for or against a proposed merger or acquisition.
D. Determining the amount of the dividend to be paid per share.
57. The current market value of Alpha Plc is N50. The current dividend level of the
company is N3 per share and is expected to grow at 10%. What is the required
rate of return?
A. 10%
B. 15%
C. 16.60%
D. 15.60%
58. According to the dividend growth model, which of the following will increase the
current value of a stock? An increase in __________
I.
II.
III.
IV.
Dividend amount.
Number of future dividends, provided the current number is less than infinite.
Discount rate.
Dividend growth rate.
A.
B.
C.
D.
I and II only.
III and IV only.
I, II and III only.
I, II and IV only.
59. Which of the following statements related to preferred stock is correct?
A. Preferred shareholders normally receive one vote per share of stock owned.
B. Preferred shareholders determine the outcome of any election that involves a
proxy fight.
C. Preferred shareholders are considered to be the residual owners of a
corporation.
D. Cumulative preferred shares are more valuable than comparable noncumulative shares.
60. Which one of the following statements is correct?
A. The capital gains yield is the annual rate of change in a stock's price.
B. Preferred stocks have constant growth dividends.
C. A constant dividend stock cannot be valued using the dividend growth model.
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D. The dividend growth model can be used to compute the current value of any
stock.
61. The Blue Group is owned by a group of 5 shareholders who all vote independently
and who all want personal control over the firm. What is the minimum percentage
of the outstanding shares one of the shareholders must own if he or she is to gain
personal control over the firm, given that the firm uses straight voting?
A. 17%
B. 20% plus one vote.
C. 25% plus one vote.
D. 50% plus one vote.
62. Which of the following provides a market platform for the buying and selling of
securities issued by companies, government and statutory bodies on the basis of
wide distribution of ownership and adequate disclosure of information?
A. The Nigerian Stock Exchange.
B. Securities & Exchange Commission.
C. Federal Ministry of Finance.
D. Central Bank of Nigeria.
63. How much are you willingly to pay for one share of XYZ stock if the company just
paid a N0.70 annual dividend, the dividends increase by 1.6% annually, and you
require a 10% rate of return?
A. N8.29
B. N8.33
C. N8.47
D. N8.53
64. Any company seeking application at the Nigerian Stock Exchange will only be
entertained if sponsored by a/an____________ of the Exchange.
A. Issuer.
B. Shareholder.
C. Dealing member.
D. Reporting accountant.
65. A stock pays a constant annual dividend and sells for N56.10 a share. If the
market rate of return on this stock is 15.85 percent, what is the amount of the
next annual dividend?
A. N7.67
B. N7.94
C. N8.21
D. N8.89
66. Which of the following is equal to the present value of all cash proceeds received
by a stock investor?
A. Dividend payout ratio.
B. Retention ratio.
C. Discount rate.
D. Value.
67. Which of the following statements is most likely true for a zero-growth stock?
A. Market value can always be increased by decreasing the plowback ratio.
B. The stock’s dividend yield is greater than the stock’s required rate of return.
C. The stock pays zero dividends.
D. The stock’s price one year from today should be the same as its current price.
Fixed Income Valuation and Analysis (68 - 100)
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68. The written agreement between a company and the bondholder’s representative
is called ___________
A. The debenture.
B. The collateral maintenance agreement.
C. The indenture.
D. The prospectus.
69. Which of the following loans is typically secured?
A. Sinking fund debenture.
B. Mortgage bond.
C. Floating rate note.
D. Eurobond.
70. If a
A.
B.
C.
D.
bond is callable, this means __________
The issuer may change the coupon rate.
The investor may convert the bond into stock.
The issuer may redeem the bond early.
The investor may cash in the bond at any time.
71. Why is a sinking fund useful to bondholders?
A. It stops the company from going under or into default.
B. The funds are usable at the option of the bondholders.
C. When a firm has difficulty making payments this sends a signal of potential
default.
D. A large payment is necessary to fully pay off the bonds at maturity.
72. Zero-coupon bond are also called ___________
A. Original issue discount bonds.
B. Pure discount bonds.
C. Deep discount bonds.
D. All of the above.
73. Bonds with deferred call features ___________
A. Can be retired at any time prior to maturity on condition that their issuer
gives notice.
B. Can only be retired after a specified period following the date of issue.
C. Can be retired at any time, but the issuer will have to play an additional
premium.
D. Generally have no call premium.
Use the information below to answer questions 74 and 75:
An 8% annual-coupon bond has 1 year to maturity, a yield to maturity of 6% and a
par value of N1,000.
74. What is the price of this bond?
A. N1,080
B. N1,042
C. N1,018
D. N1,000
75. What is the duration of the bond?
A. 1
B. 0.90
C. 0.80
D. 0.60
76. Which of the following bond relationships is not inverse?
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A.
B.
C.
D.
Coupon and duration.
Duration and yield to maturity.
Interest rate changes and bond prices.
Duration and maturity.
77. A substitution bond swap involves an exchange of ____________
A. A bond that is overpriced for a similar bond that is underpriced.
B. Bonds in different sectors of the bond market, based on yield spread
between the sectors.
C. A bond with a short maturity for a bond with a long maturity when the
investor believes market rates will fall.
D. A short-duration bond for a long-duration bond in order to increase yield.
78. Which of the following does not relate to yield to maturity (YTM)?
A. YTM depends only on the bond’s coupon, current price and par value at
maturity.
B. YTM can be interpreted as a measure of the average rate of return if the
investment in the bond is held until the bond matures.
C. YTM is the compound rate that makes the future value of a bond’s payments
equal to its price.
D. The bond’s yield to maturity is the internal rate of return on an investment
in the bond.
79. A bond invoice price is equal to __________
A. The present value of coupon interest payments plus the present value of par
value.
B. The present value of par value plus accrued interest.
C. The flat price plus accrued interest.
D. The flat price plus the present value of remaining coupon interest payments.
80. A bond which gives the bondholder the option to exchange the bond for ordinary
shares prior to maturity is a __________
A. Callable bond.
B. Floating-rate bond.
C. Puttable bond.
D. Convertible bond.
81. If the 3-year spot rate is 12% and the 2-year spot rate is 10%, what is the oneyear forward rate of interest two years from now?
A. 3.7%
B. 16.1%
C. 9.5%
D. None of the above.
82. What is another name for default risk?
A. Interest rate risk.
B. Inflation risk.
C. Credit risk.
D. Liquidity risk
83. The “yield curve” shows __________
A. Interest rate observed at a point in time, on securities of different maturity.
B. Bond prices, computed for various alternative discount rates.
C. Nominal interest rates, for various alternative expected inflation rates.
D. Real interest rates, computed at various alternative expected inflation rates.
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84. Jim owns a corporate bond issued by Ray Ltd. The company is doing fine and it
pays its coupons in a timely manner. But Jim wants to sell the bond and his
broker is having a hard time finding a willing buyer. Jim appears to be having a
first-hand encounter with ________
A. Liquidity risk.
B. Inflation risk.
C. Operational risk.
D. Default risk.
85. Bonds rated below BBB (Baa) are called _________
A. Investment grade bonds.
B. Junk bonds.
C. Risk-free bonds.
D. Debentures.
86. Suppose we observe a bond currently priced at N1,066. Its face value is
N1,000. We would refer to this as a _________
A. Par bond.
B. Premium bond.
C. Junk bond.
D. Discount bond.
87. A “zero-coupon” bond __________
A. Has zero sensitivity to rate changes.
B. Always sells at a premium.
C. Has no face value.
D. Can never sell at a premium.
88. Treasury Inflation-Protected Securities (TIPS) adjust __________
A. Coupon payments for inflation.
B. The principal payment for inflation.
C. (A) and (B) above.
D. None of the above.
89. The interest rates used to find the “fair present value” of a security is called the
___________
A. Coupon interest rate.
B. Required rate of return.
C. Realized rate of return.
D. Effective annual rate.
90. Consider a zero-coupon bond with face value of N1,000 and 5 years to maturity.
The bond’s yield to maturity is 9%. What is its duration?
A. 9.00
B. 1.09
C. 1.90
D. 5.00
91. Consider a bond having the following information:
Face value
N1,000
Maturity
Coupon rate
Payment structure
7 years
8.0%
Annual (just one payment at the
end of each year)
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What is the bond’s fair present value if the required rate of return is 10%?
A. N903
B. N1,104
C. N1,054
D. N1,162
92. Dedication strategy is best described as ___________
A. Matching cash flows from a fixed-income portfolio.
B. Price yield relationship of a bond.
C. Multi-period cash flow matching.
D. Exchange of one bond for similar identical bond.
93. Ceteris paribus, the price and yield on a bond are _________
A. Negatively related.
B. Positively related.
C. Sometimes positively and sometimes negatively related.
D. Not related.
94. Rebalancing of an immunized bond portfolio is necessary __________
A. Only when market interest rates change.
B. Because rebalancing incurs transaction costs.
C. Because, as time passes, the duration of a liability can change at a different
rate than the duration of an asset.
D. Because, as time passes, the duration of liabilities generally decreases while
the duration of assets generally increases.
95. Suppose the unbiased expectations theory is true. Further, we observed yields
on Treasury securities today and see the following:
1-year security:
2%
2-year security:
3-year security:
4%
5%
Which of the following is/are true?
A. The 2-year security has a 2 percent liquidity premium.
B. The 3-year security has a 1 percent liquidity premium.
C. We expect yields to rise in the future.
D. We expect yields to fall in the future.
96. According to the preference theory of the term structure of interest rates, the
yield curve usually should be __________
A. Inverted.
B. Normal.
C. Upward sloping.
D. (B) and (C) above.
97. A short term unsecured promissory note that is issued in the open market and
represents the obligation of the issuing company is called _________
A. Bankers’ acceptance.
B. Treasury note.
C. Collateralized debt obligation.
D. Commercial paper.
98. Floating rate bonds
A. Bonds that pay
B. Bonds that pay
C. Bonds that pay
are ____________
no coupon.
a variable income over time.
one coupon at the maturity of the bond.
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D. Bonds that pay a fixed coupon over time.
99. Debt securities are often called fixed-income securities because ____________
A. The government fixes the maximum rate that can be paid on bonds.
B. They are held predominantly by older people who are living on fixed incomes.
C. They pay a fixed amount at maturity.
D. They promise either a fixed stream of income or a stream of income
determined by a specific formula.
100. What are collateralized bonds? They ____________
A. Rely on the general earning power of the firm for the bond’s safety.
B. Are backed by specific assets of the issuing firm.
C. Are considered the safest assets of the firm.
D. (B) and (C) above.
Total = 100 marks
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