QUIZ #3 Financial Management

* Required

PART 1: CONCEPTUAL

Consider it pure joy, my brothers and sisters, whenever you face trials of many kinds,  because you know
that the testing of your faith produces perseverance.  Let perseverance finish its work so that you may be
mature and complete, not lacking anything.

James 1:2-4

1. Which of the following statements is/are true regarding valuation of bonds and preferred
stocks ? *

a. Both bonds and preferred stocks are fixed-income securities.

b. The interest payment or dividend is fixed at the time of issuance, is contractual, and
occurs at regular intervals.

c. We apply the same general approach to valuing bonds and preferred stock – that is,
we determine the present value of a fixed payment stream.

d. All statements are true

2. Which of the following is/are true regarding fixed income security? *

a. Treasury securities are totally not risk-free since as interest rates fluctuates so is
the value of a Treasury security.

b. The coupon rate is fixed and simply determines what the bond’s coupon payments
will be.

c. The required return is what investors actually demand on the issue, and it will
fluctuate through time.

d. The coupon rate and required return are equal only if the bond sells for exactly at
par.

e. All of the above

3. Which of the following is/are true regarding bonds ? *

a. Treasury bonds have no credit risk since it is backed by the U.S. government, so a
rating is not necessary.

b. Junk bonds often are not rated because there would be no point in an issuer paying
a rating agency to assign its bonds a low rating.

c. Companies pay to have their bonds rated simply because unrated bonds can be
difficult to sell; many large investors are prohibited from investing in unrated issues.

d. All of the above

4. Which of the following is/are false regarding bond yields ? *

a. Unlike YTM and required return, the coupon rate is not a return used as the interest
rate in bond cash flow valuation but is a fixed percentage of par over the life of the
bond used to set the coupon payment amount.

b. Yield to maturity is the required rate of return on a bond expressed as a nominal

annual interest rate. Bond price and yield move in the same directions.

c. Assuming you buy a 4 percent coupon, 20-year bond today when it’s first issued. If
interest rates suddenly rise to 10 percent, then the bond price will fall.

d. All else the same, the lower the coupon rate on a bond, the greater is its price
sensitivity to changes in interest rates.

5. Which of the following is false regarding bond price ? *

a. The shorter the maturity of a bond, the greater is its price sensitivity to changes in
interest rates.

b. If the coupon rate is higher than the required return, the bond sells at premium on
the other hand, if the coupon rate is lower than the required return, the bond sells at
discount.

c. The market value of the bond approaches its par value as the time to maturity
declines. The yield to maturity on the other hand, approaches the coupon interest rate
as the time to maturity declines

d. The required return on the bonds is likely to differ from the coupon rate because
either economic conditions have changed, causing a shift in the basic cost of long-
term funds, or the firm’s risk has changed.
6. Which of the following is true regarding time value of money? *

a. Financial managers rely more on present value than future value because they
typically make decisions before the start of a project, at time zero, as does the
present value calculation.

b. The annuity due results in a greater value as compared to the ordinary annuity.
Since cashflow occurs at the beginning rather than at the end of the year, it has one
additional year of compounding.

c. The more frequent the compounding the larger the future value.

d. All of the above statements are true.

7. Below refers to the theories frequently cited to explain the general shape of the yield curve:
i. According to the expectations hypothesis, the shape of the yield curve results from the
interest rate expectations of market participants. More specifically, it holds that any long-
term interest rate simply represents the geometric mean of current and future one-year
interest rates expected to prevail over the maturity of the issue. ii. The theory of liquidity
preference holds that long-term securities should provide higher returns than short-term
obligationes because investors are willing to accept lower yields for short-maturity
obligations to avoid the higher price volatility of long-maturity bonds. iii. Market
segmentation theory suggesting that the market for loans is segmented on the basis of
maturity and that the supply of and demand for loans within each segment determine its
prevailing interest rate; the slope of the yield curve is determined by the general relationship
between the prevailing rates in each market segment. Which of the above statements
regarding theories of term structure is/are true? *

a. All statements are true.

b. Statement i and iii are false.

c. Statement ii is true

d. All statements are false

8. The following statements refers to the factors affecting bond price or the bond price
volatility: (I.) Bond prices move inversely to bond yields (interest rates). (II.) For a given
change in yields (interest rates), longer maturity bonds experience larger price changes; thus,
bond price volatility is directly related to term to maturity. (III.) Bond price volatility
increases at a diminishing rate as term to maturity increases. (IV.) Bond price movements
resulting from equal absolute increases or decreases in yield are not symmetrical. A decrease
in yield raises bond prices by more than an increase in yield of the same amount lowers
prices. (V.) Higher coupon issues show smaller percentage price fluctuation for a given
change in yield; thus, bond price volatility is inversely related to coupon. Which of the above
statements are true regarding bond price volatility? *

a. All statements are true.

b. Statement I, II, III and V are true.

c. Statement IV and V are false.

d. All statements are false.

9. The following statements refer to the determinants of market interest rates: i. The real
risk-free rate of interest, is the interest rate that would exist on a riskless security if no
inflation were expected. It may be thought of as the rate of interest on short-term treasury
securities in an inflation-free world.ii. Inflation Premium is a premium equal to expected
inflation that investors add to the real risk-free rate of return. The expected inflation
premium does not change over time in response to factors, such as changes in monetary and
fiscal policies, currency movements, and international political events.iii. Default Risk
Premium is the difference between the interest rate on a U.S. Treasury bond and a corporate
bond of equal maturity and marketability. The average default risk premiums vary over time
and tend to get smaller or decreases when the economy is weaker, and borrowers are more
likely to pay-off their debts.i. Liquidity Premium is a premium added to the equilibrium
interest rate on a security if that security cannot be converted to cash on short notice and at
close to its “fair market value.”ii. Interest Rate Risk is the risk of capital losses to which
investors are exposed because of changing interest rates.iii. Maturity Risk Premium is a
premium that reflects interest rate risk. iv. Reinvestment Rate Risk is the risk that a decline
in interest rates will lead to lower income when bonds mature, and funds are
reinvested.Which of the above are false statements regarding determinants of interest rate ? *

a. Statements iii, iv and v

b. Statements ii and iii

c. Statement v

d. None all statements are true

10. Read the statements regarding financial budgeting: I. The statistics-based behavioral
approach that applies predetermined probability distributions and random numbers to
estimate risky outcomes is called scenario analysis.II. Simulation use several possible
alternative situations to obtain a sense of the variability among different levels of return.III.
The greater the variability of cash flows from day to day, the greater the amount of attention
is required.IV. In developing a budget, investment strategies need to be coordinated with the
financing strategies. Which of the following statements is/are true? *

a. I and II are False; III and IV are True

b. I, II and III are True, IV is False

c. I and II are True, III and IV are False

d. All statements are False

11. Which of the following are basic factors to consider in preparing a budget? *

a. Length of trade cycle

b. Length of production cycle

c. Nature of demand for the product

d. All of the above

12. Which of the following are basic factors to consider in preparing a sales forecast? *

a. Past experience or sales trend

b. General and industry-specific economic conditions

c. Consumer behavior

d. All of the above

13. The following statements pertains to the preparation of a pro-forma income statement: I.
Pro-forma income statement assumes costs are variable thus, it may understate the increase
in profits that will occur when sales increase if some of the firm’s costs are fixed.II. A pro
forma income statement constructed using the percentage-of sales method generally tends to
understate profits when sales are increasing and overstate profits when sales are
decreasing.III. Percentage-of-sales is used to forecast sales and then expresses the various
income statement items as percentage of projected sales. IV. Fixed costs make a firm’s profits
more variable than its revenues. When both profits and sales are rising, profits tend to
increase at a faster rate, but when profits and sales are in decline, the percentage drop in
profits is often greater than the rate of decline in sales.Which of the following statements is/
are false? *

a. All statements are True

b. I, II and IV are False, IV is True

c. I and IV are True, II and III are False

d. All statements are False

14. Which of the following is/ are true regarding external financing required? *

a. A positive external financing required means that, based on its plans, the firm will
not generate enough internal financing to support its forecast growth in assets.

b. A negative external financing required indicates that, based on its plans, the firm
will generate more financing available for use in repaying debt, repurchasing stock, or
increasing dividends.

c. Under a judgmental approach for developing a pro-forma balance sheet, the

amount of external financing needed brings the balance sheet into balance.

d. All of the above statements are true

15. Which variables usually have the most effect on the growth rate in sales? *

a. Asset-to-Sales ratio

b. Debt-to-Equity ratio

c. Quick assets

d. Only (a) and (b) based on the choices

16. Which of the following is/ are true about a firm’s cash cycle? *

a. Since cash cycle is equal to operating cycle minus the accounts payable period, it is
not possible for the cash cycle to be longer than the operating cycle if the accounts
payable period is positive.

b. It is unlikely that the accounts payable period would ever be negative since that
implies the firm pays its bills before they are incurred.

c. If a company stretched out its payment period for its bills payable it will thereby
shorten its cash cycle.

d. All of the above statement are true.

17. Which of the following transaction would increase, decrease and has no effect on a
company’s cash balance? i. Inventory is bought on credit. ii. A short-term bank loan is repaid.
iii. Production supplies are purchased and paid for with a short-term note. iv. Marketable
securities are sold. v. Preferred stock is redeemed. *

a. Increase – iv; Decrease – ii & v; No effect – i&iii

b. Increase – ii & iv ; Decrease – i; No effect – iii & v

c. Increase – i; Decrease – ii; No effect – iii, iv & v

d. Increase – iii; Decrease – ii; No effect – I, iv & v

18. What would be the impact (increase, decrease or no change) of the following transactions
on the operating cycle of a company? I. The terms of cash discounts offered to customers are
made less favorable.II. The cash discounts offered by suppliers are decreased; thus, payments
are made earlier.III. An increased number of customers begin to pay in cash instead of with
credit. IV. Fewer raw materials than usual are purchased. V. A greater percentage of raw
material purchases are paid for with credit. VI. More finished goods are produced for
inventory instead of for order. *

a. Increase – I & VI; Decrease – III & IV; No effect – II & V

b. Increase – IV & VI ; Decrease – II & V; No effect – I & III

c. Increase – VI; Decrease – IV & V; No effect – I, II & III

d. Increase – I, II & VI; Decrease – III, IV & V; No effect – None

19. A firm uses the following model to determine the optimal average cash balance (Q). An
increase in which one of the following would result in a decrease in the optimal cash balance?
*

a. Uncertainty of cash outflows.

b. Cost of a security trade.

c. Return on marketable securities.

d. Cash requirements for the year.

20. All of the following can be utilized by a firm in managing its cash outflows except: *

a. zero-balance accounts.

b. centralization of payables.

c. controlled disbursement accounts.

d. lock-box system.

21. Which one of the following instruments would be least appropriate for a corporate
treasurer to utilize for temporary investment of cash? *

a. U.S. Treasury bills.

b. Money market mutual funds.

c. Commercial paper.

d. Municipal bonds.

22. Which one of the following statements best characterizes U.S. Treasury bills? *

a. They have no coupon rate, no interest rate risk, and are issued at par.

b. They have an active secondary market, one-to-twenty-four-month maturities, and

monthly interest payments.

c. They have an active secondary market, the interest received is exempt from federal
income tax, and there is no interest rate risk.

d. They have no coupon rate, no default risk, and interest received is subject to federal
income tax.
23. James Smith is the new manager of inventory at American Electronics, a major retailer.
He is developing an inventory control system and knows he should consider establishing a
safety stock level. The safety stock can protect against all of the following risks, except for
the possibility that: *

a. customers cannot find the merchandise they want, and they will go to the
competition.

b. shipments of merchandise from the manufacturers are delayed by as much as one

week.

c. the distribution of daily sales will have a large variance, due to holidays, weather,
advertising, and weekly shopping habits.

d. new competition may open in the company’s market area.

24. Carnes Industries uses the Economic Order Quantity (EOQ) model as part of its
inventory control program. An increase in which one of the following variables would
increase the EOQ? *

a. Carrying cost rate.

b. Purchase price per unit.

c. Ordering costs.

d. Safety stock level.

25. Moss Products uses the Economic Order Quantity (EOQ) model as part of its inventory
management process. A decrease in which one of the following variables would increase the
EOQ? *

a. Annual sales.

b. Cost per order.

c. Safety stock level.

d. Carrying costs.

26. A manufacturer with seasonal sales would be most likely to obtain which one of the
following types of loans from a commercial bank to finance the need for a fixed amount of
additional capital during the busy season? *

a. Transaction loan.

b. Insurance company term loan.

c. Installment loan.

d. Unsecured short-term term loan.

27. Which of the following financing vehicles would a commercial bank be likely to offer to
its customers?I. Discounted notesII. Term loansIII. Lines of creditIV. Self-liquidating loans *

a. I and II.

b. III and IV.

c. I, III and IV.

d. I, II, III and IV.

28. The amount of cash that a firm keeps on hand in order to take advantage of any bargain
purchases that may arise is referred to as its : *

a. Transactions balance.

b. Compensating balance.

c. Precautionary balance.

d. Speculative balance.

29. The economic order quantity (EOQ) formula can be adapted in order for a firm to
determine the optimal mix between cash and marketable securities. The EOQ model assumes
all of the following except *

a. The cost of a transaction is independent of the dollar amount of the transaction

and interest rates are constant over the short run.

b. An opportunity cost is associated with holding cash, beginning with the first dollar.

c. The total demand for cash is known with certainty.

d. Cash flow requirements are random.

30. The credit and collection policy of Amargo Co. provides for the imposition of credit
block when the credit line is exceeded and/or the account is past due. During the month,
because of the campaign to achieve volume targets, the general manager has waived the credit
block policy in a number of instances involving big volume accounts. The likely effect of this
move is *

a. Deterioration of aging of receivables only.

b. Increase in the level of receivables only.

c. Deterioration of aging and increase in the level of receivables.

d. Decrease in collections during the month the move was done.

31. A strict credit and collection policy is in place in Star Co. As Finance Director you are
asked to advise on the propriety of relaxing the credit standards in view of stiff competition
in the market. Your recommendation will be favorable if : *

a. The competitor will do the same thing to prevent lost sales.

b. there is a decrease in the distribution level of your product, and a more aggressive
stance in necessary to retain market share.

c. The projected margin from increased sales will exceed the cost of carrying the
incremental receivables.

d. The account receivable level is improving, so the company can afford the carrying
cost of receivables.

32. The level of accounts receivable will most likely increase as *

a. Cash sales increase and number of says sales.

b. Credit limits are expanded, credit sales increase, and credit terms remain the same.

c. Credit limits are expanded, cash sales increase, and aging of the receivables is
improving.

d. Cash sales increase, current receivables ratio to past due increases, credit limits
remain the same.

33. If a firm had been extending trade credit on a 2/10, net/30 basis, what change would be
expected on the balance sheet of its customer if the firm went to a net cash 30 policy? *

a. Increased payables and increased bank loan.

b. Increased receivables.

c. Decreased receivables.

d. Decrease in cash.
34. Computer Services is an established firm that sells computer hardware, software and
services. The firm is considering a change in its credit policy. It has been determined that
such a change would not change the payment patterns of the current customers. To
determine whether such a change would be beneficial, the firm has identified the proposed
new credit terms, the expected additional sales, the expected contribution margin on the
sales, the expected bad debt losses, and the investment in additional receivables and the
period of the investment. What additional information, if any, does the firm require to
determine the profitability of the proposed new policy as compared to the current credit
policy? *

a. The credit standards that presently exist.

b. The new credit standards.

c. The opportunity cost of funds.

d. No additional information is needed.

35. The longer the firm's accounts payable period, the: *

a. longer the firm's cash conversion cycle is.

b. shorter the firm's inventory period is.

c. more the delay in the accounts receivable period.

d. less the firm must invest in working capital.

36. 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 ratio 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.

37. It provides an automated and integrated approach to managing a business. It may consist
of a suite of software applications (modules) that record, report, analyze and interpret data
for a range of business operations, including production, marketing, human resources,
accounting and inventories management. *

a. Enterprise Resource Planning (ERP)

b. Materials Requirements Planning (MRP) I

c. Just-In-Time (JIT) Approach

d. Lean System

38. The following are the limiting assumptions for EOQ Model, except: *

a. demand for an inventories item can be predicted with accuracy and is constant
over the period and does not fluctuate through seasonality or for other reasons

b. Order quantity is received all at once

c. No shortages are allowed and lead time for the receipt of orders is constant

d. None of the above

39. Refer to the figure below regarding the graphical representation of Economic Order
Quantity (EOQ). I. As the level of inventories and the size of inventories orders increase, the
annual costs of placing orders will decrease because fewer orders will be placed.II. The total
costs curve, which is based on the sum of holding costs and ordering costs, will fall until the
point E. III. Point E represents the minimum total cost. It also represents half of the
optimum amount that should be ordered on each occasion. IV. An optimum order size leads
the ordering cost and holding cost equal. Which of the following statements is/are true
regarding the figure below? *

a. All statements are true

b. All statements are true except I

c. I, II and III only

d. I and IV only
40. Below are the possible changes in the internal and external business environment: 
External I. Changes in interest ratesII. Changes in market demand for the business’ outputIII.
Seasonality variationsIV. Changes in the state of the economy InternalV. Changes within
the business strategies such as different production methodsVI. Changes in the level of risk
that managers are prepared to takeWhat kinds of changes in the business environment might
lead to a decision to change the level of investment in working capital? *

a. All the factors mentioned may affect the management’s decision to change the
level of investment in working capital.

b. I, II, III and IV only since they are external factors

c. V and VI only since they are internal to the business

d. None of the above are factors that may affect working capital management

41. Below are statements regarding Baumol’s model for cash management:I. The model can be
applied only when the payments position can be reasonably assessed.II. Under this model,
cash flows are assumed to be constant and known over the time period.III. The model
assumes that behavior of cash inflow and outflow is assumed to be too smooth and
certain.Which of the following statements is/are correct? *

a. Statement I only

b. Statement II and III only

c. Statement II only

d. All statements are correct

 42. Below are statements regarding economic order quantity (EOQ) model for inventory
management:I. EOQ model may be used for goods that are sold in relatively constant
amounts throughout the year. A more complicated model is needed for firms whose sales
fluctuate in response to seasonal or other cyclical factors.II. Costs associated with shortages,
delays or lost sales are not considered in EOQ Model. These costs are considered in the
determination of safety level in the reorder-point subsystem.III. The safety stock level is the
minimum level of inventory that the firm wishes to hold as a protection against running out.
Since the firm must always be above this level, the EOQ formula need not consider the costs
of maintaining the safety stock level.Which of the following statements is/are correct? *

a. Statement I only

b. Statement I and II only

c. Statement III only

d. All statements are correct

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