Name : _______Anna Budaeva___________ Date:_______________

CORPORATE FINANCE
MIDTERM
Instructions : You are given 2 hours to answer the following multiple choice questions and essays.
Please show all work. You are allowed to use a financial calculator or a smart phone using an
application for a financial calculator. A formula sheet will be provided.

Multiple Choice Questions

1. Shareholders of Corporations can be among others: I) Individuals, II) Corporations III)

pension funds
a. I, II& III 

b. I&III 

c. Only II 


2. Which of the following asset is tangible?

a. Exxon-Mobil's corporate headquarters building 

b. Apple Computer's trademark 

c. Hewlett-Packard's most recent printer patent 

d. Microsoft's technical expertise 


3. A corporation has infinite life because

a. is a legal entity. 

b. has the same ownership and management. 

c. has limited liability. 

d. is closely regulated.

4. Which of the following is not a financial asset?

a. common stock 

b. bank loans 

c. preferred stock 

d. buildings 


5. Which of the following is an important function of financial markets?


 I) providing financing; II) providing liquidity; III) reducing risk; IV) providing information 

a. I only

b. I and II only 

c. I, II, III, and IV
d. IV only 


6. The financial goal of a corporation is to:

a. maximize profits 

b. maximize sales. 

c. maximize the value of the firm for the shareholders. 

d. maximize managers' benefits. 


7. The discount rate is used for :

a. Calculating the PV of cashflows 

b. Calculating duration 

c. Finding the exchange rate 


8. Present value is defined as:

d. future cash flows discounted to the present by an appropriate discount rate.
e. inverse of future cash flows. 

f. present cash flows compounded into the future. 


9. The rate of return is also called the: I) discount rate; II) hurdle rate; III) opportunity cost of capital
g. I only. 

h. I and II only. 

i. I, II, and III. 

j. I and III only. 


10. The present value of an investment is $100,000 after 1 year. The initial investment was
$50,000. What is the Net Present Value : 

a. $10,000.
b. $100,000.
c. $50,000.
d. $0. 

Answer: PV= $100,000
Initial investment = $50,000
NPV = PV - required (initial) investment.
NPV= $100,000- $50,000= $50,000

11. An initial investment of $400,000 is expected to produce an end-of-year cash flow of

$480,000. What is the Net Present Value

a. $176,000

b. $80,000 

c. $0 (zero)
d. $480,000 


12. If the present value of a cash flow generated by an initial investment of $200,000 is $250,000,
what is the NPV of the project?
a. $250,000
b. $50,000
c. $200,000
d. -$50,000

Answer: PV= $250,000

Initial investment = $200,000
NPV = PV - required (initial) investment.
NPV = -200,000 + 250,000 = 50,000.

13. The relationship between bonds and interest rate is

a. Proportional
b. Inversely proportional
c. No relationship
d. Cannot be determined

14. Callable Bonds have a risk for the following

a. Bondholders
b. Bond issuer
c. No risk
d. Both Bondholder and Issuer

15. According to the net present value rule, an investment in a project should be made if the:
a. net present value is greater than the cost of investment.
b. net present value is greater than the present value of cash flows.
c. net present value is positive.
 d. net present value is negative.

16. 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 security of similar risk as the project.
d. the expected rate of return on a typical bond portfolio.

17. A perpetuity is defined as a sequence of:

a. equal cash flows occurring at equal intervals of time for a specific number of periods.
b. equal cash flows occurring at equal intervals of time forever.
c. unequal cash flows occurring at equal intervals of time forever.
d. unequal cash flows occurring at equal intervals of time for a specific number of
periods.

18. What is the present value of $10,000 per year in perpetuity at an interest rate of 10%?
a. $10,000
b. $100,000
c. $200,000
d. $1,000

Answer: PV= C/r; C=10,000; r=10% (0.10)

PV = 10,000/0.10 = 100,000.

19. The present value of $121,000 expected one year from today at an interest rate (discount
rate) of 10% per year is:
a. $121,000.
b. $100,000.
c. $110,000.
d. $108,900.

Answer: PV= C1/(1+r)t

PV = (121,000)/(1.10) = 110,000.

20. What is the net present value of the following cash flow sequence at a discount rate of 11%?
a. $69,108.03
b. $231,432.51
c. $80,000.00
d. $88,000.00

21. An initial investment of $500 produces a cash flow of $550 one year from today.
Calculate the rate of return on the project.
a. 10%
 b. 15%
c. 20%
d. 25%

Answer: Rate of Return= Profit/Investment;

Rate of Return = (550-500)/500= 0.1 =10%

22. A government bond issued in Germany has a coupon rate of 5%, a face value of 100 euros, and
matures in five years. The bond pays annual interest payments. Calculate the price of the bond (in
euros) if the yield to maturity is 3.5%.
a. 100.00
b. 106.77
c. 106.33
d. 105.00

Answer: Price of the bond =PV

Annual Interest Payment= 100*0.05= 5

PV = (5/1+0.035) + (5/(1+0.035)2) + (5/(1+0.035)3) + (5/(1+0.035)4) + (105/(1+0.035)5) =

106.77.

23. A government bond issued in Germany has a coupon rate of 5%, a face value of 100.00
euros, and matures in five years. The bond pays annual interest payments. Calculate the
yield to maturity of the bond (in euros) if the price of the bond is 106.00 euros.
a. 5.00%
b. 3.80%
c. 3.66%
d. 6.00%

Answer: Annual Interest Payment= 100*0.05= 5

Price of the bond = PV= 106.00 euros
106= (5/1+r) + (5/(1+r)2) + (5/(1+r)3) + (5/(1+r)4) + (105/(1+r)5)
r= 3.66%

24. A three-year bond with 10% coupon rate and $1,000 face value yields 8%. Assuming
annual coupon payments, calculate the price of the bond.
a. $857.96
b. $951.96
c. $1,000.00
d. $1,051.54

Answer: Annual Interest Payment= 1,000*0.1= 100

Price of the Bond= PV
PV= (100/1+0.08) + (100/(1+0.08)2) + (1100/(1+0.08)3)= 1,051.54
 25. A five-year treasury bond with a coupon rate of 8% has a face value of $1,000. What is
the semiannual interest payment?
a. $80
b. $40
c. $100
d. $50

Answer: Annual Interest Payment = 1000*0.08 = 80.

Semiannual Interest Payment = 80/2 = 40.

26. If a bond pays interest semiannually, then it pays interest:

a. once per year
b. every six months
c. every three months
d. every two years

27. Which bond is a SAFE bond?

a. A Corporate Bond AAA
b. A High Yield Bond
c. A French Bond

28. What is the definition of a yield curve?

a. It is the return you receive on a bond
b. It is the return of a U.S. government bond
c. It is the return of a stock

29. What is a zero coupon bond

a. Coupon payments every month
b. Coupon payments every year
c. No coupon payments until maturity

30. What is duration

a. How long you will keep the bond
b. Time in years of when you will get your initial investment
c. How long the time to get your return

ESSAY QUESTIONS:

1. Briefly explain the sequence of cash flows between financial debt markets and the firm.
 The sequence of cash flows between Financial Debt Markets and the Firm

2) 1)
Financial Financial Dept
FIRM 4.1)
Manager Markets
(its operations)
(investors)

3) 4.2)

1) Cash is raised by selling financial assets to Investors (issuance and trading of debt securities)
2) Cash is invested in to the Firm's operation (and used to purchase real assets).
3) Cash is generated by the Firm's operations.
4.1) Cash is reinvested.
4.2) Cash is returned to investors.

(Financial Manager- refers to anyone responsible for financial decision (investment) of the firm)

2. Briefly discuss what are the risk of buying a bond.

The main risk, that bondholders face is, that the issuer will default, and in result, be unable
to repay the money, which was borrowed, at maturity. The level of the Risk of Default is
directly depends on the financial strength of the bond issuer. That’s why, when corporations
(or governments) plan to issue bonds, they ask and pay a Credit-Rating company to evaluate,
how likely it is, that they will repay the money.

In result, the two systems of bond’s rating were established by Moody’s and Standard &
Poor’s in order to measure the risk of bonds.

Aaa (Moody’s)/AAA (Standard & Poor’s)- the SAFE bonds

Investment Grade High rated, means issuers are very rare to default

Baa (Moody’s) /BBB (Standard & Poor’s)

High-yield/Junk bonds Low rated, means very risky, issuers will default, potentially

C(Moody’s) /C(Standard & Poor’s)

So, in result,, some bondholders (investors) are more likely to buy the least risky bonds
more in order to safe money, others prefer to buy risky bonds in order to get, higher return
(High Risk= High Return), probably, if the issuer will not default.

3. Discuss how a bond works payments, coupon, cashflow, etc (Hint: Diagram could be
useful).
100$
1) Coupon Bond 5$ 5$ 5$ 5$
5$

1 year 2 year 3 year 4 year 5 year

- 100$

Let’s imagine, that we bought 5 year coupon bond.

With 100$=Future Value (Par Value) = bonds price, when it is first issued, amount issuer must repay
at maturity.
5 year coupon bond, means, that each year, we will get the interest payment (amount paid on each
coupon), provided by the issuer of the bond, we bought.
This Interest Payment is calculated by multiplying the price of the bond (Future value=100$) by the
Coupon Rate- is interest of the return that bondholders earn for loaning their funds to the issuer (which
is 5% in our example): 100*5%=5$, so for each Coupon Dates- dates on which the issuer will make
interest payments (most of the dates are annual or semi-annual, in our case they are annual), we will get
annual interest payment of 5$. So every year, until the bonds mature, we will collect interest payments.

The 5th year- maturity (data), we will get the final interest payment (of 5$ in our case) and, also, we get
back the Face Value of the bond (100$). So, we have the following Annual Cash payments:

1st YEAR = 5$
2nd YEAR= 5$
3rd YEAR= 5$ 5 years Cash Flow= 125$
4TH YEAR =5$
5th YEAR= 105$

Then in order to identify value of the bond, we need to find the Present Value (the price of a bond) of
all Cash Flows: FV and coupons, generated by the bond, discounted at Yield to Maturity-the rate of
return (3,5% in our case). So, in our case, PV= 106.77. So, PV (106.77)> FV (100), meaning, that this
is bond is selling at Premium (so its priced at more, than its principal amount).

(If PV<FV, means, that bond selling at Discount-priced less than its principal amount; If PV=FV,
means the bond is selling at Par-priced at the same amount as its principal amount)

2) Zero Coupon Bond 100$

0 0 0 0
0

1 year 2 year 3 year 4 year 5 year

- 100$

However, in case, if you are a bondholder of a Zero Coupon Bond, you are not receiving any interest
payments (so, no coupons). The only cash payment you receive is the Face Value of the bond at
maturity (100$, for example). The way to gain in the Zero Coupon Bond is to benefit on the

difference between the price, on which you bought the bond, and the amount received at maturity,
because Zero Coupon Bonds are traded at Discount (are priced less than they principal amount).

4. Explain the term duration?

Duration- is the time, measured in years, of when the bondholder will get his/her initial
investment.
For example:
1,000$
500$ 500$ 500$ 500$

500$

1 year 2 year 3 year 4 year 5 year

-1,000$

Let’s imagine, that you buy a 5 year Coupon Bond (for example).
With Face value of 1,000$, and Coupon Rate= 50%, so the Annual Interest Rate=
1,000*50%= 500$.
Thus, for the 1st year you earn 500$, then for the 2nd year-another 500$. In result, at 2nd
year (after receiving your another 500$), you receive your initial investment of 1,000$
(500$+500$= 1st year + 2nd year= 1,000$= 2 years)

Thus, Duration = 2 years.

If to look at myth, in order to calculate Duration, very complex formula is used:

Duration= 1*PV(C1)/PV + 2*PV(C2)/PV +…+ T*PV(Ct)/PV.
However, it is certain, that:
- for the Coupon Bonds, Duration< Maturity, always.
- for the Zero Coupon Bonds, Duration=Maturity, always.

5. BONUS: Explain the current yield curve in the U.S.