14. Interest rates are important to financial institutions, like banks, since an increase in interest rates ________ the cost of acquiring funds and ________ the income from financial assets.
    A. decreases; decreases

    B. increases; increases C. decreases; increases D. increases; decreases

15. (I) Debt markets are often referred to generically and collectively as the bond market. (II) A bond is a security that is a claim on the residual earnings and assets of a corporation after contractual payments are made to stockholders.
    A. (I) is true | (II) false.

    B. (I) is false | (II) true. C. Both are true.
    D. Both are false.

16. Financial markets have the basic function of

    1. bringing together people with funds to lend and people who want to borrow

       funds.

    2. assuring that the swings in the business cycle are less pronounced.

    3. assuring that governments need never resort to printing money.

    4. both A and B of the above.

    5. both B and C of the above.

17. Which of the following securities would be classified as a money market instrument? A. Stock

    B. Long Term Bond
    C. Commercial Paper
    D. Mortgage Backed Security

18. IPOs are launched in the _________ market. A. Debt

    B. Residual C. Primary D. Secondary

19. The agency problem called Empire-Building occurs when

    1. A firm’s CEO is more interested in increasing the size of the corporation, rather than the

       size of its profits.

    2. The CEO increases the scope of a business in order to limit competition.

    3. The CEO is granted maximum compensation with a minimum "strings."

    4. The CEO expands the firm’s footprint in order to increase economies of scale.

20. When the lender and the borrower have different amounts of information regarding a transaction, ________ is said to exist.
    A. asymmetric information
    B. adverse selection

    C. moral hazard D. fraud

21. If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is
    A. 7%
    B. 22%.

    C. -15% D. -8%

22. A decrease in the expected rate of inflation will ________ the expected return on bonds relative to returns on ________ assets.
    A. reduce | financial
    B. reduce | real

    C. increase | financial D. increase | real

23. The interest rate that is adjusted for actual changes in the price level is called the A. ex post real interest rate.
    B. expected interest rate.
    C. ex ante real interest rate.

    D. none of the above.

24. When the demand for bonds ________ or the supply of bonds ________, interest rates fall.

    1. Increases | increases

    2. Increases | decreases

    3. Decreases | decreases

    4. Decreases | increases

25. The demand for an asset rises if ________ falls. A. risk relative to other assets
    B. expected return relative to other assets C. liquidity relative to other assets

    D. wealth

If Moody's or Standard and Poor's downgrades its rating on a corporate bond, typically the demand for that bond ________ and its yield ________.
A. Increases | decreases
B. Decreases | increases

26. C. Increases | increases D. Decreases | decreases

Taxation

a) Define the tax wedge. What does full shifting mean?

b) Why does taxation generate welfare losses?

Machalo Limited is a fashion company. Michael, one of the ‘bright young things’ who works in the design department, has come up with a new style of a T-shirt – the D’urberville. The product is not expected to have a long sales run but will be popular whilst it lasts.
Two methods of promoting the T-shirt are available:
Method 1: ‘swamping the market’ – this would involve an initial advertising campaign costing K100,000 and would result in net cash inflows after one year of K230,000. However, commission of K132,000 would have to be paid one year after the inflows.
Method 2: waiting for the market to develop gradually. This would involve an initial advertising campaign costing K70,000 and would result in net cash inflows of zero after one year and K38,000 at the end of each of the subsequent three years.
Mrs Kangwa, a director of Machalo Limited, has commented: ‘Method 1 can’t be acceptable since the net receipts of K230,000 are less than the total outflows of K232,000. Method 2 can’t be adopted since the expense of K70,000 in a year with no revenue to show for it will mean that we won’t have enough money to pay the dividend which our shareholders require.’
Machalo Limited’s cost of capital is 15%. The directors do not expect capital to be in short supply during the next four years.
Page 3 of 13
Required:
a) Calculate the net present values and estimate the internal rates of return of the two methods of promoting the new product.
b) Advise the directors of Machalo Limited which method they should adopt, explaining the reasons for your advice and noting any additional information you think would be helpful in making the decision.
c) Comment on the views expressed by Mrs Kangwa.

Explain Five (5) limitations of financial ratios.

Bee LLC is considering purchasing equipment to boost its business. Given the information below, conduct the required capital budgeting analysis to offer your recommendation. Use five of the following seven methods. Please detail any assumptions made and show your calculations for your recommendation.

• Net Present Value
• Internal Rate of Return
• Modified Internal Rate of Return
• Profitability Index
• Payback Period
• Discounted Payback Period
• Average Accounting Return

Finally, calculate DeltaNPV/DeltaPrice.

Case     

To purchase the equipment, Bee LLC incurs the following costs:

Equipment purchase price          $35,700,000    

Equipment useful life           5 years, Straight Line Depreciation Rate 20% per year

Equipment Salvage value       $4,670,000       

Required R&D                  $1,200,000, to choose the right equipment

Marketing study                $450,000, to ascertain market potential                          

Bee LLC intends to produce a unique gadget with the following cost structure:

Unit Price                                                   $525

Unit Variable Cost                                          $310

Fixed Cost                                              6,200,000

Tax Rate                                                      30%

Estimate of the Annual Net Working Capital of Sales      25%

Required Return                                             15%

The company’s projections for sales are shown below:

Projected Sales    Year +1             Year +2             Year +3             Year +4             Year +5

Sales(units)           75,000             98,000              115,000             105,000              65,000

Two years ago, you invested $2,650. Today, it is worth $3,450. What rate of interest did you earn?

a) 4.31 percent

b)14.10 percent

c)7.05 percent

d)1.18 percent

(a) Explain TWO(2) features of corporate bonds as a long-term debt instrument.

(b) Milkot Berhad issues a 15-year bond of RM1,000 that pays RM85 annually. The market price for the bond is RM960. Your required rate of return is 9%. Calculate the following:

    (i) What is the value of the bond to you?

    (ii) What is the value if your required rate of return increases to 11%?

    (iii) What will be the value if your required rate of return decreases to 7%?

   (iv) Based on (ii) & (iii) above, under which circumstances should you purchase the bond.

You need to have $33,250 in 11 years. You can earn an annual interest rate of 4 percent for the first 6 years, and 4.6 percent for the next 5 years. How much do you have to deposit today?

Which is true for a firm’s overall cost of equity:

Select one:

a.  It is generally less than a leveraged firm’s WACC

b. Ii is unaffected by changes in the market risk premium

c.  It is generally less than the firm’s after-tax cost of debt

d. It is dependent on growth rate and risk level of the firm

a. Denny and Janice (and their dog Chewy) have just purchased a house and are calculating how much money they will need when the closing day rolls around. The purchase price is $200,000. They will make a 20% down payment, and they must pay 2 points on the loan. Closing costs should be 3% of the purchase price. What is the total dollar amount they will need at closing? (Show all work.)

b. Benny and Sally want to calculate the difference in monthly payments on a $110,000 home as a result of a $5,000 down payment or a $10,000 down payment. Use your financial calculator to figure the monthly payments, assuming they get a 6.5%, 30-year mortgage.

c. If a lender requires that mortgage payments cannot exceed 30% of gross income and total loan payments cannot exceed 38% of gross income, calculate the monthly payment for which a person with the following financial data could qualify.

Gross Income $5,500
Stereo loan payment 250
Furniture loan payment 200
Auto loan 400

A firm's cost of capital:

Select one:

a. depends on source of funds used for a project

b. is independent of firm's capital structure

c. depends on how funds are going to be spent

d. will decrease as the firm-risk increases

1). Explain the Fed's three tools of monetary policy and how each is used to change the money supply. Does each tool affect the monetary base or the money multiplier?

2). Suppose everything else equal; a) the Central Bank raises the reserve requirement to 20 percent, b) the currency deposit ratio rises to 60 percent. Which development, a) or b) will affect the money multiplier more? Why?

3). Suppose the Central Bank of Turkey starts to pay interest on reserves. Under what circumstances this would affect the short term policy interest rate?

2. An investor plans to retire in 10 years. As part of the retirement portfolio, the investor buys a newly issued, 12-year, 8% annual coupon payment bond. The bond is purchased at par value, so its yield-to-maturity is 8.00% stated as an effective annual rate.

a. Calculate the approximate Macaulay duration for the bond, using a 1 bp (0.01%) increase and decrease in the yield-to-maturity and calculating the new prices per 100 of par value to six decimal places.

b. Calculate the duration gap at the time of purchase. (Hint: An investor plans to retire in 10 years. So, this investor’s investment horizon is 10 years.)

c. Does this bond at purchase entail the risk of higher or lower interest rates?

d. A bond is currently trading for 98.722 per 100 of par value. If the bond’s yield-to-maturity (YTM) rises by 10 basis points, the bond’s full price is expected to fall to 98.669. If the bond’s YTM decreases by 10 basis points, the bond’s full price is expected to increase to 98.782. What is the bond’s approximate convexity?

1. Abdul Inc., wants to raise $1 million by issuing six-year zero coupon bonds with a face value of $1,000. Its investment banker states that investors would use an 11.4 percent discount rate to value such bonds. At what price would these bonds sell in the marketplace? How many bonds would the firm have to issue to raise $1 million? Assume semi-annual interest payments.

(b) Investor A holds a 15-year bond, while investor B has an 7-year bond. If interest rate increases by 1 percent, which investor will have the higher interest rate risk? Explain.

(c) Investor A holds a 10-year bond paying 8 percent a year, while investor B also has a 10-year bond that pays a 6 percent coupon. Which investor will have the higher interest rate risk? Explain.

2.Assume the following for a one-year rate adjustable rate mortgage loan that is tied to the one-year Treasury rate: Loan amount: $200,000 Annual rate cap: 1% Life-of-loan cap: 4% Margin : 2.50% First-year teaser rate: 5.50% One-year Treasury rate at end of year 1: 5.25% One-year Treasury rate at end of year 2: 5.50% Loan term in years: 15 Given these assumptions, calculate the following: a.Initial monthly payment b.Loan balance end of year 1 c.Year 2 contract rate d.Year 2 monthly payment e.Loan balance end of year 2 f.Year 3 contract rate g.Year 3 payment