COLLEGE OF MANAGEMENT AND ACCOUNTANCY

FIN 072 FINANCIAL MARKETS

FIRST PERIODICAL EXAMINATION 2ND SEMESTER 2019-2020

Part I. Multiple Choice

Direction: Shade the letter that corresponds your answer on the answer sheet provided. Strictly NO
ERASURES. Use black ink. ( I point for each correct answer.)

1. Which of the following instruments is not traded in a money market?

a. Banker’s acceptances c. Eurodollars
b. U.S. Treasury Bills d. Commercial paper
e. None of the above

2. Which of the following can be described as involving direct finance?

(a) A corporation issues new shares of stock.
(b) People buy shares in a mutual fund.
(c) A pension fund manager buys a short-term corporate security in the secondary market.
(d) An insurance company buys shares of common stock in the over-the-counter markets.

3. Which of the following can be described as involving indirect finance?

(a) A corporation issues new shares of stock.
(b) People buy shares in a mutual fund.
(c) A pension fund manager buys a short-term corporate security in the secondary market.
(d) Both (a) and (b) of the above.
(e) Both (b) and (c) of the above.

4. Which of the following statements about financial markets and securities are true?
a. A bond is a debt security that promises to make payments for a specified period of time.
b. Equities often make periodic payments called dividends and are considered to be long-term
securities because they have no maturity date.
c. A debt instrument is short term if its maturity is less than ten years.
d. All of the above are true.
e. Only (a) and (b) of the above are true.

5. An important function of secondary markets is to

a. make it easier to sell financial instruments to raise cash.
b. raise funds for corporations through the sale of securities.
c. create a market for bank demand deposits.
d. create a market for newly constructed houses.
e. make it easier for governments to raise taxes.

6. Which of the following statements is most correct?

a. Money markets are markets for long-term debt and common stocks.
b. Primary markets are markets where existing securities are traded among investors.
c. A derivative is a security whose value is derived from the price of some other “underlying” asset.
d. Statements a and b are correct.
e. Statements b and c are correct.

7. Which of the following assets is traded only in an over-the-counter market?

a. treasury bonds c. commodities
b. stocks d. all of the above
e. none of the above

8. You recently sold 200 shares of Disney stock to your brother. This is an example of:
a. A money market transaction. c. A secondary market transaction.
b. A primary market transaction. d. A futures market transaction.
e. Statements a and b are correct.

9. Financial intermediaries lower costs by spreading them over a large number of customers, thereby
taking advantage of
a. risk sharing. c. economies of scale.
b. diversification. d. asymmetric information
e. transactions costs.

10. The benefit of risk sharing to customers of financial institutions is

a. reduced liquidity. c. reduced liability.

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b. reduced diversification. d. reduced risk.
e. reduced return.

11. The risk that securities cannot be sold at a reasonable price on short term notice is called:
a. Default risk c. Purchasing power risk
b. Interest rate Risk d. Liquidity risk

12. The marketable securities with the least amount of default risk are:
a. Federal government agency securities c. Philippine treasury securities
b. Repurchase agreements d. Commercial Paper

13. A measure that describes the risk of an investment project relative to other investments in general is
the:
a. Long-term bonds have a maturity date and must be repaid in the future.
b. Investors are exposed to greater risk with equity capital.
c. The interest on debt is a legal obligation.
d. Equity capital is in greater demand than debt capital.

14. From the viewpoint of the investor, which of the following securities provides the least risk?
a. Mortgage bond c. Income bond
b. Subordinated debenture bonds d. Debentures

15. The future value of a lump sum at the end of five years is $1,000. The nominal interest rate is 10
percent and interest is compounded semiannually. Which of the following statements is most correct?
a. The present value of the $1,000 is greater if interest is compounded monthly rather than
semiannually.
b. The effective annual rate is greater than 10 percent.
c. The periodic interest rate is 5 percent.
d. Statements b and c are correct.
e. All of the statements above are correct.

16. Which of the following bank accounts has the highest effective annual return?
a. An account that pays 10 percent nominal interest with monthly compounding.
b. An account that pays 10 percent nominal interest with daily compounding.
c. An account that pays 10 percent nominal interest with annual compounding.
d. An account that pays 9 percent nominal interest with daily compounding.

17. Which of the following investments has the highest effective annual rate (EAR)? (Assume that all CDs
are of equal risk.)
a. A bank CD that pays 10 percent interest quarterly.
b. A bank CD that pays 10 percent monthly.
c. A bank CD that pays 10.2 percent annually.
d. A bank CD that pays 10 percent semiannually.
e. A bank CD that pays 9.6 percent daily (on a 365-day basis).

18. Suppose someone offered you the choice of two equally risky annuities, each paying $10,000 per
year for five years. One is an ordinary (or deferred) annuity, the other is an annuity due. Which of the
following statements is most correct?
a. The present value of the ordinary annuity must exceed the present value of the annuity due, but the
future value of an ordinary annuity may be less than the future value of the annuity due.
b. The present value of the annuity due exceeds the present value of the ordinary annuity, while the
future value of the annuity due is less than the future value of the ordinary annuity.
c. The present value of the annuity due exceeds the present value of the ordinary annuity, and the
future value of the annuity due also exceeds the future value of the ordinary annuity.
d. If interest rates increase, the difference between the present value of the ordinary annuity and the
present value of the annuity due remains the same.
e. Statements a and d are correct.

19. Which of the following statements is most correct?

a. The present value of an annuity due will exceed the present value of an ordinary annuity (assuming all
else equal).
b. The future value of an annuity due will exceed the future value of an ordinary annuity (assuming all
else equal).
c. The nominal interest rate will always be greater than or equal to the effective annual interest rate.
d. Statements a and b are correct.
e. All of the statements above are correct.

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20. You plan to invest $5,000 at the end of each of the next 10 years in an account that has a 9 percent
nominal rate with interest compounded monthly. How much will be in your account at the end of the 10
years?
a. $ 75,965 c. $ 84,616
b. $967,571 d. $ 77,359
e. $ 80,631

21. You observe the following information regarding Company X and Company Y:
 Company X has a higher expected mean return than Company Y.
 Company X has a lower standard deviation than Company Y.
 Company X has a higher beta than Company Y.

Given this information, which of the following statements is most correct?

a. Company X has a lower coefficient of variation than Company Y.
b. Company X has more company-specific risk than Company Y.
c. Company X is a better stock to buy than Company Y.
d. Statements a and b are correct.
e. Statements a, b, and c are correct.

22. In general, which of the following will tend to occur if you randomly add additional stocks to your
portfolio, which currently consists of only three stocks?
a. The expected return of your portfolio will usually decline.
b. The company-specific risk of your portfolio will usually decline, but the market risk will tend to remain
the same.
c. Both the company-specific risk and the market risk of your portfolio will decline.
d. The market risk and expected return of the portfolio will decline.
e. The company-specific risk will remain the same, but the market risk will tend to decline.

23. Risk premium for an individual security is computed as:

a. the security’s covariance divided by the variance of the market.
b. beta times the market return.
c. difference between the required return and risk free rate.
d. weighted average of the individual security betas in a portfolio.

24. Which of the following best describe a company with beta coefficient of zero?
a. It is more responsive than the market portfolio.
b. It has the same response as the market portfolio.
c. It is less responsive than the market portfolio.
d. It is unaffected by market movement.

25. A firm whose portfolio has a beta coefficient of -1 represents an asset that
a. is more responsive than the market portfolio.
b. has the same response as the market portfolio but in opposite direction.
c. is less responsive than the market portfolio.
d. It is unaffected by market movement.

26. Interest paid (earned) on both the original principal borrowed (lent) and previous interest earned is
often referred to as
a. present value c. future value
b. simple interest d. compound interest

27. You deposited $1,000 in a savings account that pays 8 percent interest, compounded quarterly,
planning to use it to finish your last year in college. Eighteen months later, you decide to go to the Rocky
Mountains to become a ski instructor rather than continue in school, so you close out your account.
How much money will you receive?
a. $1,171 c. $1,082
b. $1,126 d. $1,163
e. $1,008

28. Which of the following statements is most correct?

a. The future value of an annuity due is greater than an otherwise identical ordinary annuity.
b. A reduction in the discount rate will increase the future value of an otherwise identical cash flow
stream.

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 c. Continuous compounding will result in a higher present value relative to an otherwise identical
investment that is compounded monthly at the same nominal rate.
d. The FVIFA (i%, N periods) equals the sum of the PVIF(i%, n) for n=1 to N periods.

29. Which of the following statements is most correct?

a. We would observe a downward shift in the required returns of all stocks if investors believed that
there would be deflation in the economy.
b. If investors became more risk averse, then the new security market line would have a steeper slope.
c. If the beta of a company doubles, then the required rate of return will also double.
d. Statements a and b are correct.
e. All of the statements above are correct.

30. What is the future value of a 5-year ordinary annuity with annual payments of $200, evaluated at a
15 percent interest rate?
a. $ 670.44 c. $1,169.56
b. $ 842.91 d. $1,522.64
e. $1,348.48

Part II. Problem Solving: Show a properly labeled solution and ENCIRCLE your FINAL ANSWER.

1. You are considering buying a new car. The sticker price is $15,000 and you have $2,000 to put toward
a down payment. If you can negotiate a nominal annual interest rate of 10 percent and you wish to pay
for the car over a 5-year period, what are your monthly car payments?

2. Today is your 21st birthday, and you are opening up an investment account. Your plan is to contribute
$2,000 per year on your birthday and the first contribution will be made today. Your 45th, and final,
contribution will be made on your 65th birthday. If you earn 10 percent a year on your investments, how
much money will you have in the account on your 65th birthday, immediately after making your final
contribution?

3. The ShortHolder bank pays 5.60%, compounded daily (based on 360 days), on a 9-month certificate of
deposit. If you deposit $20,000 you would expect to earn around __________ in interest.

4. Assume that you will receive $2,000 a year in Years 1 through 5, $3,000 a year in Years 6 through 8,
and $4,000 in Year 9, with all cash flows to be received at the end of the year. If you require a 14 percent
rate of return, what is the present value of these cash flows?

5. The risk-free rate is 5 percent. Stock A has a beta = 1.0 and Stock B has a beta = 1.4. Stock A has a
required return of 11 percent. What is Stock B’s required return?

6. A stock has an expected return of 12.25 percent. The beta of the stock is 1.15 and the risk-free rate is
5 percent. What is the market risk premium?

7. A money manager is holding the following portfolio:

Stock Amount Invested Beta
1 $300,000 0.6
2 300,000 1.0
3 500,000 1.4
4 500,000 1.8

The risk-free rate is 6 percent and the portfolio’s required rate of return is 12.5 percent. The manager
would like to sell all of her holdings of Stock 1 and use the proceeds to purchase more shares of
Stock 4. What would be the portfolio’s required rate of return following this change?

8. A bank customer wishes to have an amount of P300 at the end of 10 years. The bank pays an interest
of 8% per annum, compounded annually. How much money will the customer have to invest with the
bank now?

9. You plan to borrow P389,000 now and repay it in equal annual installments (payment will be made at
the end of each year). If the annual interest rate is 14%, how much will your annual payments be?

10. You are offered an investment with a quoted annual interest rate of 13% with quarterly
compounding of interest. What is your effective annual interest rate?

“ The longest and toughest journey is the most rewarding.”