JIANGXI UNIVERSITY OF FINANCE AND ECONOMICS INTERNATIONAL SCHOOL
Corporate Finance Mid-Semester Examination, April 2006
Study Period: 10 minutes Writing Period: 180 minutes
Permitted Materials in the exam: Non-programmable calculators; Dictionary (hard copy); Pen or pencil; Rubber or correction fluid or correction tape; Drinks and tissues.
Total marks = 60 This examination counts toward 30% of your final grade for the course
INSTRUCTIONS (important!)
1. There are a total of 60 multiple-choice questions (one mark each). 2. This exam is a close-book exam and no formula sheet is given. 3. Answers are to be recorded on the answer sheet provided in the final page. In your answer sheet, cross only one answer for each question corresponding to the answer you believe to be the most appropriate (or correct). There is only one correct answer for each question. Marks will not be deducted for incorrect answers. Should you provide more than one answer for any question, your exam will not be marked and you will be awarded a mark of zero for the exam. 4. Use of mobile phone in the exam is strictly prohibited. Please turn off your mobile phone in the exam. Students who fail to follow this rule will be asked to leave the exam room and will be treated as plagiarism. 5. A hard-copy of dictionary is allowed to bring in the exam (subject to inspection at the beginning of the exam). Electronic dictionary is not allowed. Use of electronic dictionary in the exam will be treated as plagiarism. 6. Please bring your own calculator to the exam. Borrowing a calculator from someone else in the exam is not allowed. 7. Since the uses of mobile phone and electronic calculator are not allowed, this implies that you are not allowed to use the calculation functions in your mobile phone and electronic dictionary. 8. Please remember to write down your name and student number in the answer sheet. Failure to include these information will result in your script not being marked and you will be awarded a mark of zero for the exam. 9. Hand in your answer sheet only upon the completion of the exam. 10. You should stop writing following invigilator’s announcement of ending exam and are required to remain on your seat until the invigilators finish the collection of exam scripts. Continuing writing after the announcement will result in a zero mark for your exam.
1 1. Which of the following is an advantage of a partnership? (a)* It can combine the wealth and talents of several individuals. (b) The partners are personally liable for the debts of the partnership. (c) The partnership has an indefinite life. (d) Both (a) and (b).
2. Shareholders usually have the following rights: (a) A residual claim on the company’s assets and earnings (b) The right to vote on appointments to the board of directors and other important matters (c) Limited liability (d) *All of the above
3. Agency costs are incurred when: (a) Agents depart from value-maximising decisions (b) Principals incur costs to monitor agents and influence their actions (c) *Both (a) and (b) (d) None of the above
4. Agency conflicts between managers and shareholders are reduced by: (a) The monitoring of companies by specialists. (b) Including performance-based incentive in management compensation schemes (c) The threat of takeover (d) *All of the above
5. Which of the following is not an advantage associated with the separation of ownership and control that occurs within companies? (a) Companies can exist forever (b) Company ownership can be transferred without affecting the operations of the firm (c) Professional managers can be hired to run the firm. (d) *Agency costs are incurred
6. Which of the following is a characteristic unique to redeemable preference shares: (a) The company is required to pay any accumulated preference dividends before a distribution can be made to ordinary shareholders. (b)* The shares may be re-purchased by the company out of profits or the proceeds of a new share issue. (c) The shares may be converted into ordinary shares. (d) Holders of redeemable preference shares may be entitled to a return in excess of the stated preference dividend rate.
7. Subordinated debtholders will demand a higher interest rate than unsubordinated debtholders because: (a) Unsubordinated debt is riskier. (b) Subordinated debt ranks ahead of unsubordinated debt in the event of liquidation. (c) *Unsubordinated debt ranks ahead of subordinated debt in the event of liquidation. (d) The interest rate on subordinated debt tends to be fixed rather than variable.
2 8. Which characteristic of preference shares, which are legally regarded as equity security, is a similar to a characteristic exhibited by debt securities? (a) *They pay a fixed rate dividend (b) They do not expire in a specific period of time, while most debt securities have a maturity date. (c) Payment of dividends is at the discretion of the directors (d) None of the above
9. An overnight loan is a loan made on the understanding that either party may terminate the loan by giving notice no later than the following morning. (a) *11 a.m. (b) 9 a.m. (c) 10:30 a.m. (d) 10 a.m.
10. Which of the following is a disadvantage of a sole proprietorship? (a) It is easy to start up and manage the business. (b) It is more expensive to establish than a company. (c)* It can be difficult to raise funds for expansion. (d) Both (a) and (c)
11. Which of the following statements best reflects the financial objective of a company? (a) To minimise the operational risk facing the company. (b) To maximise the accounting profit of the company. (c) To provide the best possible dividend outcome for shareholders in any given year. (d)* To maximise the market value of shareholders’ equity.
12. If a company is wanting to investment funds for a short period of time, they can (a) Buy out a company. (b) Issue a commercial bill. (c) Issue a promissory note. (d)* Buy a promissory note.
13. The role of the discounter in a bill of exchange is to: (a) Act as a negotiator. (b)* Provide the funds by acting as the initial purchaser of the bill. (c) Write up the documents.
14. When comparing debentures and unsecured notes, it can be said that: (a) They are identical securities. (b) A debenture holder is an unsecured creditor whereas an unsecured note holder is a secured creditor. (c) Both are examples of unsecured debt. (d)* A debenture holder is a secured creditor whereas an unsecured note holder is an unsecured creditor.
15. “Three parties are involved in the creation of a promissory note are namely the drawer, the acceptor, and the discounter”. This statement is (a) True (b) *False
3 16. Trade credit is equivalent to a short-term loan equalling to the selling price made by the purchaser to the seller. (a) True (b) *False
17. Dividend irrelevance is based on the premise that investors: (a) Have a preference for dividends over capital gains (b) Dislike dividends and prefer capital gains (c)* Are indifferent between dividends and capital gains (d) Are taxed on both dividends and capital gains
18. The advantage of a dividend reinvestment scheme is: (a) *A lowering of transactions costs for investors (b) A reduction in the tax liability of dividend incomes (c) The new shares are sold at a premium (d) It increases the value of the company
19. The bird in the hand argument assumes that investors prefer: (a) *Current dividends to future dividends (b) Future dividends to current dividends (c) Firms with low payout ratios (d) None of the above
20. The difference between share repurchases and cash dividends is that (a) Repurchased shares don’t participate in the dividend reinvestment scheme (b) A repurchase reduces the number of shares on issue (c) Tax consequences for investors may differ (d) *All of the above
21. If both dividends and capital gains are subject to the same tax rate, the effective tax rates for dividends and capital gains can differ because: (a) Capital gains are a tax on paper gains, while dividends are a tax on cash flow. (b) *Dividends are taxed when distributed, while capital gains are deferred until the share is sold (c) Both dividends and capital gains are taxed every year (d) All of the above
22. A characteristic of franked dividends which differentiate them from unfranked dividends is: (a) *Franked dividends carry tax credits related to the income tax paid by the company. (b) Franked dividends are indexed for inflation, while unfranked dividends are not. (c) None of the above
23. The existence of a tax-induced clientele effect suggests that: (a) Dividend policy is important (b) Investors will pay a premium for a firm with a preferred dividend policy (c) The value of the firm is a linear function of dividend payout (d) *The value of the firm is independent of dividend payout
4 24. Calculate the average annual rate of return on an investment of $1,000 that accumulates to $2,005 in 5 years’ time. (a) *14.93% (b) 8.8% (c) 100.5% (d) 17.63%
25. Share price changes around the time of announcements of dividend changes are positively related to the change in dividends. This evidence may not invalidate the dividend irrelevance theorem because: (a) Investors are indifferent between capital gains and dividend income. (b) Debt is not necessarily affected by such announcements. (c) Share prices revert back to pre-dividend levels following the announcement. (d)* It is not the dividend payments that determine the value of shares but information about the future cash flows that is conveyed by the announcement.
26. Which of the following statements best describes the tax-induced clientele effect? (a) *Investors subject to high dividend tax rates (relative to capital gains tax rates) would prefer shares of companies that pay low dividends (b) Investors subject to high dividend tax rates (relative to capital gains tax rates) would prefer shares of companies that pay high dividends (c) Investors subject to high dividend tax rates (relative to capital gains tax rates) are indifferent to the dividend payout rate (d) Investors subject to high capital gains tax rates (relative to dividend tax rates) would prefer shares of companies that pay low dividends
27. Examine the following probability distribution Return Probability 0.02 0.1 0.04 0.2 0.06 0.4 0.08 0.2 0.10 0.1
The mean and standard deviation are: (a) 0.06 and 0.0693, respectively (b) 0.06 and 0.0693, respectively (c) *0.06 and 0.022, respectively (d) 0.07 and 0.022, respectively
28. You have a goal to raise $1,000 in 4 years’ time. If your mother gives you $400 at the end of the first year, you make six deposits of equal amounts every 6 months thereafter, and all the money is deposited in a bank, which pays 8% p.a., compounded semi-annually, how large must each of the six payments be for you to reach your target? (a) *$74.46 (b) $65.55 (c) $82.74 (d) $77.26
5 29. You have $10,000 to invest. If you invest it at 11.2% p.a. for 6 months, then invest the initial $10,000 together with any interest for a further 12 months at 12.7% p.a., what will be the value of your investment at the end of the 18-month period? (a) *$11,901.12 (b) $12,532.24 (c) $11,830.00 (d) $12,241.36
30. If a term deposit paid an interest rate of 24% p.a. over the past 6 months, and the current balance is $1,008, what was the amount initially invested? (a) $812.90 (b) $681.08 (c) *$905.21 (d) $975.00
31. Karen has borrowed $12,000 in a (principal and interest) student loan at an annual interest rate of 9%. If she repays $1,500 per annum, how long (to the nearest year) will it take to repay the loan? (a) 10 years (b) 12 years (c) *15 years (d) 17 years
32. Debt Ltd borrowed a principal and interest loan of $100,000 from its local bank to finance the purchase of new equipment. Annual payments are required over 5 years at a fixed interest rate of 10% p.a. How much is each annual payment? (a) $27,398.18 (b) $20,000.00 (c)* $26,379.75 (d) $24,444.12
33. Debt Ltd borrowed $100,000 from its local bank to finance the purchase of new equipment. Annual payments are required over 5 years at a fixed interest rate of 10% p.a. Calculate the principal component of the first annual payment. (a) $17,398.18 (b) $14,444.12 (c) $10,000.00 (d)* $16,379.75
34. A portfolio consists of two assets, A and B. The expected return and standard deviation of asset A are 0.10 and 0.03, respectively. The expected return and standard deviation of asset B are 0.15 and 0.05, respectively. Increasing the amount of wealth in Asset A whilst the entire wealth invested in the portfolio remains unchanged, this: (a) will increase the expected return of the portfolio. (b) will decrease the expected return of the portfolio, but the expected return will be higher than before. (c)* will decrease the expected return of the portfolio, but the expected return will still be greater than if the portfolio consisted of asset A only. (d) None of the above
6 35. Five years ago, you entered into a principal and interest loan agreement to borrow $100,000. The loan was to be paid off over 20 years through equal monthly instalments. If the interest rate was fixed at 12% p.a. for the entire loan term, calculate the value of the loan outstanding today. (a) *$91,744 (b) $86,777 (c) $93,111 (d) $80,119
36. What is the effective annual interest rate corresponding to a nominal interest rate of 10% p.a., compounding continuously? (a) *10.5% (b) 10.9% (c) 12.5% (d) 13%
37. The benefit of diversification to an investor is: (a) the reduction of brokerage costs. (b) the reduction of brokerage costs and risk. (c) *the reduction of unsystematic risk. (d) the reduction of risk.
38. Risk aversion implies that: (a) an investor will prefer a higher expected return than a lower expected return. (b) an investor will refuse to bear any risk at all. (c) *an investor will tolerate extra risk if it is expected that the return will compensate them for bearing it. (d) an investor will be indifferent to the level of risk providing that the expected return is identical.
39. A risk-averse investor attaches: (a) increasing utility to each increment in wealth. (b)* decreasing utility to each increment in wealth. (c) increasing utility to each increment in risk. (d) no utility to each increment in risk.
40. Beta is a measure of: (a) the extent to which the returns on the stock market as a whole change over time. (b) the extent to which the prices of a given stock move with the price levels of the stock market. (c) *the extent to which the returns on a given stock move with the returns of the stock market. (d) the extent to which a security’s risk can be eliminated by diversification.
41. If a share has a beta of 1.5 and the expected return on the market over the next 10 years is 11% per annum, what is the expected risk premium on the security over the next year if the risk-free rate of return is 4%? (a) 14.5% (b) 21% (c) 7% (d)* 10.5%
7 42. The variance of a portfolio does not depend on: (a) the proportion of the current market value of the portfolio constituted by each security. (b) the variance of the possible returns of each security. (c) *the standard deviation of the market. (d) the correlation between returns on the securities held in the portfolio.
43. An ‘efficient’ portfolio is one that: (a) combines assets whose returns are not perfectly correlated. (b) offers the highest expected return for a given level of risk. (c) offers the lowest level of risk for a given expected return. (d) *both (b) and (c)
44. Calculate the expected return from a portfolio consisting of 3 securities with the following expected returns and weights: Expected Return Weight Security A 0.10 50% Security B 0.12 30% Security C 0.14 20%
(a) 0.114% (b) 12% (c) *11.4% (d) 36%
45. Systematic risk represents: (a) non-diversifiable risk. (b) risk that is unavoidable. (c) risk that is diversifiable. (d) *Both (a) and (b).
46. Which of the following is not an example of unsystematic risk? (a) *Changes in the level of interest rates. (b) The chief executive officer resigns. (c) A legal suit against a company for environmental pollution. (d) The development of a new product line.
47. A high price-earnings ratio normally signifies: (a) high earnings per share, other things being equal. (b) *an investment with good growth opportunities. (c) a riskier investment. (d) an investment with poor growth opportunities.
48. You have a choice between receiving $505 now and $530 in 6 months’ time. Current interest rates are 10% p.a. (simple interest). As a rational investor, which option would you choose under a simple interest arrangement? (a) *$505 now (b) $530 in 6 months’ time,
8 49. Consider a 10-year bond with a face value of $1,000 and with an annual coupon of $100. What is its market value if the appropriate required rate of return is 6% p.a.? (a) $2,000 (b) *$1,294.40 (c) $1,349.51 (d) $1,752.12
50. What is the expected return on an asset with a beta of 2.0, if the risk-free rate of interest is 5% and the market risk premium is 10%? (a) 15% (b) 20% (c) 10% (d) *25%
51. Assume that XYZ Ltd has a current growth rate of 10% p.a. that is expected to be maintained for only another 3 years and then fall to 5% p.a., where it is expected to remain indefinitely. Given that the required return on ABC’s shares is 12% and that the last dividend of 50c has just been paid, the price of ABC’s shares will be: (a) *$8.56 (b) $11.43 (c) $10.25 (d) $9.82
52. If a share has a beta of 1.5 and the expected return on the market over the next 10 years is 11% per annum, what is the expected risk premium on the security over the next year if the risk-free rate of return is 4%? (a) 14.5% (b) 21% (c) 7% (d) *10.5%
53. Investors whose indifference curve is at a point of tangency to the capital market line but above the market portfolio point are: (a) risk neutral. (b) lenders at the risk-free rate. (c) *borrowers at the risk-free rate. (d) risk seekers.
54. How much would you be prepared to pay for a share in 2 years’ time that pays a $0.15 dividend each year forever and is currently priced at $2? Assume the required rate of return remains at 7.5% p.a. forever. (a) $1.87 (b) $2.30 (c) $1.70 (d) *$2
9 55. The difference between the required rate of return for a risky security and a risk- free rate is referred to as the: (a) required rate of return. (b) term premium. (c) market risk premium. (d) *risk premium.
56. Suppose that Maker Ltd issues an 8% 10-year bond with a face value of $100. If the required rate of return is 10% p.a., the market value of the bond is less than $100. (a)* True (b) False
57. Assume the latest dividend per share, paid recently, for ACD Ltd is $0.90 and that the required rate of return on these shares is 15% p.a. If the current share price is $19.80, the expected growth rate on these shares is: (a) 0% (b) *10% (c) 5% (d) 7.5%
58. Given that dividends on a share are expected to remain indefinitely at $1 p.a. and that the required rate of return for the level of risk on such a share is 15%, the correct price for this share: (a) cannot be ascertained from this information. (b) cannot be ascertained without regard to the management structure of the firm. (c) is $1 (d)* is $6.67
59. You have just purchased a government bond for $1,100 that promises to pay $100 p.a. over the next 5 years. The market price of the bond has just increased to $1,200. A likely reason for this is: (a) the face value of the bond has been increased. (b) the bond is perceived by the market to be more risky now than before. (c) interest rates, in general, have increased. (d)* interest rates, in general, have decreased.
60. One reason that the required rate of return on shares is generally more than on debt securities is because: (a) borrowers may default on payments. (b) the returns on shares are higher than on debt securities. (c)* debtholders rank ahead of shareholders in case of liquidation. (d) shareholders rank ahead of debtholders in case of liquidation.
End
10 Name: Student ID: Answer Sheet Cross only one correct answer for each question.
A B C D A B C D 1. 31.
2. 32.
3. 33.
4. 34.
5. 35.
6. 36.
7. 37.
8. 38.
9. 39.
10. 40.
11. 41.
12. 42.
13. 43.
14. 44.
15. 45.
16. 46.
17. 47.
18. 48.
19. 49.
20. 50.
21. 51.
22. 52.
23. 53.
24. 54.
25. 55.
26. 56.
27. 57.
28. 58.
29. 59.
30. 60.