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Student Number: _______________________
Commerce 2FA3
Final Exam
Summer 2008
Instructor: K. Brewer
Duration of Examination: 3 Hours
This examination paper includes 14 pages and 50 questions. You are
responsible for ensuring that your copy of the paper is complete. Bring any
discrepancy to the attention of your invigilator.
Special Instructions:
a) Use of Casio FX-991 calculator only is allowed for this exam.
b) Each multiple-choice question has only one right answer. Indicate your
answer on the OMR scan sheet. Correct answers will be worth 1 mark
and wrong or missing answers will be worth zero. There is no correction
factor.
c) A formula sheet will be handed out with this exam. No other references
are allowed.
Com 2FA3
Final Exam
Summer 2008
1
If projects A and B are negatively interdependent, then _________.
a) NPV A+B < NPV A + NPV B
a) NPV A+B = NPV A + NPV B
a) NPV A+B > NPV A + NPV B
a) You can’t do both A and B
a) None of the above.
2
What is the present value of the tax shield on a $75,000 class 8 asset (20%) for a firm C
with a cost of capital of 10.5%, an average tax rate of 27% and a marginal tax rate of
34% that has net acquisitions of $100,000 in class 8?
a) $12,648
0.105 
75,000  0.2  0.34 1 
b) $13,279
2

PV 
c) $15,927
0.105  0.2
 1  0.105 


d) $16,721
 15,927
e) none of the above
3
A project with an apparently negative NPV may become viable if you consider…
a) the effective annual annuity (EAA)
b) payback instead of NPV
c) AAR instead of IRR
d) managerial options
e) none of the above
4
The Monumental Co. is considering purchasing a piece of equipment costing E
$642,000. The equipment belongs in a 30% CCA class. What is the anticipated tax
shield in year three on this equipment if the company is in the 34% marginal tax
bracket?
 0.3 
a) $22,799
TS3  642,0001 
1  0.30.30.34 
2


b) $23,469
 38,963
c) $32,087
d) $33,438
e) $38,963
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A
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D
Com 2FA3
Final Exam
Summer 2008
5
The annual annuity stream of payments with the same present value as a project's E
cash flows is called the project's _____ annuity.
a) incremental
b) sunk
c) opportunity
d) erosion
e) equivalent annual
6
A pro forma financial statement is one that:
a) projects future years' operations.
b) is expressed as a percentage of the total assets of the firm.
c) is expressed as a percentage of the total sales of the firm.
d) is expressed relative to a chosen base year's financial statement.
e) reflects the past and current operations of the firm.
A
7
Projected cash flow is typically defined to be
a) an weighted average of the possible cash flows
b) the best case expected cash flow
c) the largest possible cash flow
d) the most common cash flow
e) the most likely cash flow
A
8
You own some equipment which you purchased three years ago at a cost of $135,000. A
The equipment belongs in a 25 percent CCA class, and was the only asset in this
class. You are considering selling the equipment today for $82,501. Which one of the
following statements is correct if your tax rate is 34 percent?
a) You will face recapture of depreciation.
b) You will suffer a terminal loss.
c) You will have to pay capital gains tax.
d) The UCC will be set to zero with no current tax implications.
e) None of the above.
 0.25 
UCC  135,0001 
1  0.250.25
2 

 66,445
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Com 2FA3
Final Exam
Summer 2008
9
The possibility that errors in projected cash flows can lead to incorrect NPV estimates A
is called:
a) Forecasting risk.
b) Projection risk.
c) Scenario risk.
d) Monte Carlo risk.
e) Accounting risk.
10
An electrical utility has the control room built with the capability to control up to six D
generators although the project only calls for four generators to be installed. This
gives the utility ___________.
a) a strategic option
b) the option to wait
c) a contraction option
d) an expansion option
e) an abandonment option
11
When firms do not have sufficient available financing to invest in the positive NPV E
projects they have identified, __________________ is/are said to exist.
a) excess financing
b) contingency options
c) strategic options
d) managerial options
e) capital rationing
12
HPL Inc. is evaluating two mutually exclusive capital budgeting proposals. Project A C
has a NPV of $60,000 and would last 5 years after which time it can be repeated.
Project B has a NPV of $75,000 and can be repeated after 8 years. HPL's cost of
capital is 10%. Which Project is preferred?
a) Project B because it doesn't have to be repeated as often
b) Project B because the NPV is higher
c) Project A on the basis of EAA
d) Project B on the basis of EAA
e) HPL should do both projects
60,000
60,000

 15,828
PVIFA10%,5 3.791
75,000
75,000
EAAB 

 14,058
PVIFA10%,8 5.335
EAAA 
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Com 2FA3
Final Exam
Summer 2008
13
The NPV computed using static DCF analysis is _________ if the project gives us the A
opportunity to invest additional funds if things go well; that is, it includes an option to
expand.
a) understated
b) overstated
c) accurately stated even
d) not conservative enough
e) useless
14
Which of the following statements regarding NPV analysis is correct?
C
a) NPV calculations do not depend on cash flow projections
b) Positive NPV projects that have relatively low levels of fixed costs should be
more heavily scrutinized than projects with relatively high levels of fixed
costs
c) NPV calculations are only as good as the information that goes into their
calculation
d) Negative NPV projects should be scrutinized to make sure there is a sound
economic basis underlying them
e) All of the above
15
If strong form market efficiency holds, which of the following situations should yield E
excess returns?
a) Obtaining insider information
b) Analyzing a company’s earnings report
c) Identifying a pattern in a company’s stock price
d) Following the advice of your broker’s newsletter
e) None of the above
16
In a highly competitive and efficient market, all stocks should:
a) Produce the same rate of return.
b) Plot on the same security market line.
c) Have the same beta.
d) Have the same standard deviation.
e) Plot at the intercept point.
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Com 2FA3
Final Exam
Summer 2008
17
Which one of the following statements concerning beta is correct?
D
a) The beta of a portfolio must be greater than or equal to zero but less than or
equal to one.
b) The beta of a portfolio can be greater than the highest beta of an individual
security within the portfolio.
c) If the weights of the individual securities within a portfolio are changed, the
beta of the portfolio will remain constant.
d) The beta of a portfolio measures the systematic risk of the portfolio and has a
value that can not exceed the value of the highest beta of any individual
security in the portfolio.
e) The beta of a portfolio measures the unsystematic risk of the portfolio and has
a value that must be greater than or equal to zero.
18
The concept of an efficient market implies
a) all shares of stock have the same expected returns
b) there is no upward trend in stock prices
c) prices reflect all available information
d) stock prices do not fluctuate
e) none of the above
19
Securities R and T both have an expected return of 20% with a standard deviation of A
15%. If the two securities are uncorrelated, what is the variance of a portfolio that
has 30% in security R and 70% in security T?
a) 131 basis points
b) 15%
 P2  0.32  0.152  0.7 2  0.152  0.01305
c) 18%
C
d) 25%
e) None of the above
20
In a world with 3 risky securities and a risk-free asset, Joe has an efficient portfolio. B
His holdings consist of $900 in asset A, $350 in Asset B, $750 in asset C and $500 in
the risk-free asset. Susan has $1,000 to invest. If she is not interested in borrowing
or lending, how much should she invest in Asset B if she wants an efficient portfolio?
a) $100
b) $175
350
c) $350
XB 
 17.5%
900  350  750
d) $700
e) none of the above
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Com 2FA3
Final Exam
Summer 2008
21
Under CAPM, what is beta?
a) the risk-free rate
b) the market risk premium
c) a measure of the systematic risk in a security
d) the standard deviation of the return of a security
e) a measure of the company specific risk in a security
22
Given that the standard deviation of returns for Security C is 36%, the variance of D
returns for the market is 0.0196 and the correlation between C and the market is 0.51.
What is the betaof security C?
a) Less than 0
b) 0.22

0.51 0.36  0.0196

 C2,m 
 1.31
C
c) 1
m
0.0196
d) 1.31
e) none of the above
23
A firm with a constant dividend of $2.50 per share has a beta of 0.4 and is trading at C
$25 per share. If the risk-free rate of return is 6%, what is the return on the market
portfolio?
a) 10%
2.5
r
 10%
b) 13%
25
c) 16%
E r   10  6  Rm  6 0.4
d) 19%
Rm  16%
e) none of the above
24
A stock has a beta of 1.4. The expected return on the market is 8% and T-bills are C
yielding 2%. What is the expected return on the stock?
a) 8.40%
b) 9.65%
Er   2  8  21.4  10.4%
c) 10.40%
d) 11.65%
e) 13.20%
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C
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Com 2FA3
Final Exam
Summer 2008
25
A firm with a beta of 1.25 is expected to pay a dividend of $2.25 a year from now. If D
the expected return on the market portfolio is 12% and the risk free rate is 4%, at
what rate are dividends expected to grow it the share is currently prices at $37.50?
a) 5%
E r   4  12  4  1.25  14%
b) 6%
2.25
g  0.14 
c) 7%
37.5
d) 8%
 8%
e) none of the above
26
What is the portfolio beta with 125% of your funds invested in the market portfolio E
via borrowing 25% of the funds at the risk-free interest rate?
a) 0.25
b) 0.50
c) 0.75
d) 1.00
e) 1.25
27
The excess return required on a risky asset over that earned on a risk-free asset is A
called a:
a) Risk premium.
b) Return premium.
c) Excess return.
d) Average return.
e) Variance.
28
A portfolio has an expected return of 11.57%. The portfolio consists of stock A with D
an expected return of 8.6% and stock B with a beta of 1.28. The risk-free rate of
return is 3% and the market risk premium is 8%. What is the portfolio weight of
Stock A?
E rB   3  8 1.28  13.24%
a) 31%
11.57  13.241  X B   8.6  X B
b) 32%
c) 34%
X B  0.3599
d) 36%
e) 37%
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Com 2FA3
Final Exam
Summer 2008
29
Assume that markets are semi-strong form efficient. Suppose, then, that during a B
trading day, important new information is released for the first time concerning a
certain company. This information indicates that one of the firm's oil fields,
previously thought to be very promising, just came up dry. How would you expect
the price of a share of stock to react to this information?
a) The value of a share will fall over an extended period of time as investors
begin to sell shares in the company.
b) The value of a share will drop immediately to a price that reflects the value of
the new information.
c) The value of a share will fall below what is considered appropriate because of
the decreased demand for the shares, but eventually the price will rise to the
correct level.
d) The value of a share will rise over a long period of time as investors sell the
stock.
e) The stock price will not change since this type of information has no impact in
markets that are semi-strong form efficient.
30
You own two risky assets, both of which plot on the security market line. Asset A C
has an expected return of 12% and a beta of 0.8. Asset B has an expected return of
18% and a beta of 1.4. If your portfolio beta is the same as the market portfolio, what
proportion of your funds are invested in asset A?
a) 0.33
b) 0.50
1  X A  0.8  1  X A 1.4
c) 0.67
X A  0.667
d) 1.33
e) 1.67
31
As long as the inflation rate is positive, the real rate of return on a security investment C
will be ____ the nominal rate of return.
a) greater than
b) equal to
c) less than
d) greater than or equal to
e) unrelated to
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Com 2FA3
Final Exam
Summer 2008
32
If capital markets are semi-strong form efficient, then ________________________.
A
a) there is no reason to believe that prices are too high or too low
b) it is possible to profit regularly from publicly available information
c) prices will adjust slowly when reacting to new information
d) it is not possible to make money by playing the stock market
e) historical price trends will give you a good idea of where prices are headed in
the future
33
Estimates using the arithmetic average will probably tend to _____ values over the B
long-term while estimates using the geometric average will probably tend to _____
values over the short-term.
a) overestimate; overestimate
b) overestimate; underestimate
c) underestimate; overestimate
d) underestimate; underestimate
e) accurately; accurately
34
Financial markets fluctuate daily because they:
a) are inefficient.
b) slowly react to new information.
c) are continually reacting to new information.
d) offer tremendous arbitrage opportunities.
e) only reflect historical information.
C
35
The value of an option if it were to expire today is called an option's
a) time value
b) strike value
c) market value
d) intrinsic value
e) volatility value
D
36
Which of the following contracts obligates the writer (issuer or seller) to sell an asset B
for a specified price if the contract is exercised?
a) A put option
b) A call option
c) A swap contract
d) A futures contract
e) A forward contract
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Com 2FA3
Final Exam
Summer 2008
37
DSW Inc. is issuing 10-year, 7% coupon, $1,000 face value bonds that have 20 A
warrants attached to each bond. These bonds are selling for par. Similar bonds
without warrants are selling at a price that gives a YTM of 8%. What is the value of
one warrant?
20
a) $3.40
1  1  0.04 
1,000
PBond  35 

 932.05
b) $4.95
0.04
1  0.0420
c) $8.11
1,000  932.05
PW arrant 
 3.40
d) $12.46
20
e) none of the above
38
Short-run financial risk arising from the need to buy or sell at uncertain prices or rates D
in the near future is called __________________.
a) risk maximization
b) economic exposure
c) translation exposure
d) transactions exposure
e) volatility maximization
39
A local retail store allows you to return the merchandise you purchase and get your C
money back for up to 30 days after the purchase date. The store has, in effect,
provided each shopper with _______________ options.
a) American call
b) European call
c) American put
d) European put
e) strategic
40
Hedging an asset with contracts written on a similar, but not identical, asset is called:
a) perfect-hedging
b) open trading
c) open-hedging
d) primary trading
e) cross-hedging
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E
Com 2FA3
Final Exam
Summer 2008
41
Which of the following is a characteristic difference between a warrant and a call D
option?
a) Neither warrants nor call options affect firm value.
b) Call options can be allowed to expire while warrants cannot.
c) A call option will typically have a longer maturity than a warrant.
d) Call options are issued by individuals while warrants are issued by firms.
e) Unlike warrants, when call options are exercised, the number of shares of
stock outstanding increases.
42
A(n) _____________ contract is a legally binding agreement between two parties A
calling for the purchase/sale of an asset in the future at an agreed-upon price today.
a) forward
b) spot
c) swap
d) option
e) floating
43
A farmer generally enters into a forward contract as a:
a) hedger.
b) speculator.
c) spot trader.
d) broker.
e) spectator.
44
It makes sense to exercise an American option before expiry when the underlying C
asset is a dividend paying stock _________________________.
a) anytime that the intrinsic value is positive
b) if the price of the option is greater than its intrinsic value
c) the expected dividend exceeds the time value of the option
d) the intrinsic value of the option exceeds the time value of the option
e) none of the above
45
Which of the following describes the net effect of a perfect hedge?
a) the hedger can only lose money if prices change
b) the hedger can only make money if prices change
c) the hedger can either make or lose money if prices change
d) the hedger will neither make nor lose money if prices change
e) prices will not change
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A
D
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Com 2FA3
Final Exam
Summer 2008
46
Which of the following will increase the value of a call option?
I. An increase in the T-bill rate
II. An increase in the time to expiration
III. A decrease in the strike price
IV. A decrease in the standard deviation of the return on the stock
a) I and II only
b) I and III only
c) II and IV only
d) I, II, and III only
e) II, III, and IV only
D
47
A risk profile is a plot showing how changes in:
a) Prices or rates affect the value of a firm.
b) Prices or rates affect the net present value of a project.
c) The level of risk affects prices and rates.
d) The level of risk affects the value of a firm.
e) The value of a firm causes changes in prices and rates.
A
48
In which of the following does money NOT change hands when the contract is E
created?
I. Futures contracts
II. Options contracts
III. Forward contracts
a) I only
b) II only
c) III only
d) I and II only
e) I and III only
49
Long-run financial risk:
a) includes conditions such as low grain prices in a particular year.
b) is easier to hedge over time than short-run financial risk.
c) is related more to near-term transactions than to advancements in technology.
d) generally results from changes in the underlying economics of a business.
e) can generally be hedged such that the financial viability of a firm is protected.
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D
Com 2FA3
50
Final Exam
Summer 2008
Hedging will not increase the value of the firm when
a) the level of systematic of the firm risk is reduced
b) the expected value of bankruptcy costs are reduced
c) the level of unsystematic risk of the firm is reduced
d) the hedging strategy has a negative expected cost due to backwardation
e) all of the above will increase the value of the firm
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C