Q&A Hero

Q: _________________________ allow the bank to generate fee income after they have sold a loan. The bank continues to collect interest and principal from the borrowers and passes these collections to the loan buyers.

Q: A firm has a debt-to-equity ratio of 0.50. Its cost of debt is 10%. Its overall cost of capital is 14%. What is its cost of equity if there are no taxes? A. 13% B. 16% C. 15% D. 18%

Q: A(n) _________________________ allows a homeowner to borrow against the residual value of their residence.

Q: A firm has a debt-to-equity ratio of 1.0. If it had no debt, its cost of equity would be 12%. Its cost of debt is 9%. What is its cost of equity if there are no taxes? A. 21% B. 18% C. 15% D. 16%

Q: Often when loans are securitized they are passed on to a _________________________ who pools the loans and sells securities.

Q: The cost of capital for a firm, rWACC, in a tax-free environment is: A. Equal to the expected EBIT divided by market value of the unlevered firm B. Equal to rA, the rate of return for that business risk class C. Equal to the overall rate of return required on the levered firm D. All of the above

Q: When a bank sets aside a group of income-earning assets and then sells securities based upon those assets it is ________________________ those assets.

Q: A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes its cost of equity capital with the new capital structure would be: A. 8% B. 16% C. 13% D. 10% E. None of the above

Q: Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. The company wishes to repurchase 50% of the stock and substitutes an equal value of debt yielding 8%. Suppose that before refinancing, an investor owned 100 shares of Learn and Earn common stock. What should he do if he wishes to ensure that risk and expected return on his investment are unaffected by refinancing? A. Borrow $3,000 and buy 50 more shares B. Continue to hold 100 shares C. Sell 50 shares and purchase $3,000 debt (bonds) D. None of the above

Q: Assume that two firms, one considered a high credit risk (HCR) and the other a low credit risk (LCR), are considering an interest rate swap. Each can borrow at the following rates: Fixed Rate Variable Rate LCR 8% 5% HCR 12% 7% An interest rate swap would be beneficial to both parties if: A) The LCR firm wants to borrow at the fixed rate and the HCR firm wants to borrow at the variable rate. B) The HCR firm wants to borrow at the fixed rate and the LCR firm wants to borrow at the variable rate. C) Both firms want to borrow at the variable rate. D) Both firms want to borrow at the fixed rate. E) An interest rate swap would be never beneficial in this situation.

Q: MM Proposition II states that: A. The expected return on equity is positively related to leverage B. The required return on equity is a linear function of the firm's debt to equity ratio C. The risk to equity increases with leverage D. All of the above E. None of the above

Q: The daily settlement process that credits gains or deducts losses from a futures customers account is called: A) The variation margin B) Marking-to-market C) The initial margin D) The maintenance margin E) The notional value

Q: Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the expected earnings per share value after refinancing? A. $12.00 B. $19.20 C. $24.00 D. None of the above

Q: Which of the following is a difference between futures and forward contracts? A) Futures contracts are market-to-market daily, while forward contracts are not B) Buyers and sellers deal directly with each other on forward contracts but go through organized exchanges in futures contracts C) Futures contracts are standardized, forward contracts generally are not D) Forward contracts are generally more risky because no exchange guarantees the settlement of each contract if one or the other party to the contract defaults E) All of the above are differences between futures and forward contracts

Q: Wealth and Health Company is financed entirely by common stock that is priced to offer a 15% expected return. The common stock price is $40/share. The earnings per share (EPS) is expected to be $6. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected value of earnings per share after refinancing? (Ignore taxes.) A. $6.00 B. $7.52 C. $7.20 D. None of the above

Q: A swap where the notional amount accumulates over time is called: A) A quality swap B) A bullet swap C) An amortizing swap D) An accruing swap E) None of the above

Q: Learn and Earn Company is financed entirely by Common stock that is priced to offer a 20% expected return. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the expected return on the common stock after refinancing? A. 32% B. 28% C. 20% D. None of the above

Q: A swap where the notional amount declines over time is called: A) A quality swap B) A bullet swap C) An amortizing swap D) An accruing swap E) None of the above

Q: Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected return on the common stock after refinancing? (Ignore taxes.) A. 18% B. 21% C. 15% D. None of the above

Q: A swap where the notional amount is constant is called: A) A quality swap B) A bullet swap C) An amortizing swap D) An accruing swap E) None of the above

Q: The effect of financial leverage on the performance of the firm depends on: A. The rate of return on equity B. The firm's level of operating income C. The current market value of the debt D. The rate of dividend growth

Q: Which of the following is a characteristic of a swap seller? A) They generally have a higher credit rating B) They prefer flexible short-term interest rate C) They often have a negative duration D) They generally have large holdings of short-term assets E) All of the above

Q: In an EPS-Operating Income graphical relationship, the slope of the debt line is steeper than the equity line. The debt line has a negative value for intercept because: A. The break-even point is higher with debt B. A fixed interest charge must be paid even at low earnings C. The amount of interest per share has only a positive effect on the intercept D. The higher the interest rate the greater the slope

Q: Which of the following is a characteristic of a swap buyer? A) They generally have a lower credit rating B) They prefer fixed rate longer term loans C) They often have a positive duration D) They generally have substantial holdings of longer term assets E) All of the above

Q: When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of operating income because: A. Interest payments on the debt vary with EBIT levels B. Interest payments on the debt stay fixed leaving less income to be distributed over fewer shares C. Interest payments on the debt stay fixed, leaving less income to be distributed over more shares D. Interest payments on the debt stay fixed, leaving more income to be distributed over less number of shares

Q: According to EPS-operating income graph, debt financing is preferred if the expected operating income is: A. less than the break-even income B. greater then the break-even income C. equal to the break-even income

Q: Which of the following is a characteristic of a swap seller? A) Prefers fixed-rate longer term loans B) Generally has a lower credit rating C) Often has a positive duration D) Generally has a large holding of short-term assets E) All of the above

Q: An EPS-Operating Income graph shows the trade-off between financing plans and: I) Greater risk associated with debt financing, which is evidenced by the greater slope II) Their break-even point III) The minimum earnings needed to pay the debt financing for a given level of debt A. I only B. II only C. III only D. I, II, and III only

Q: Which of the following is a characteristic of a swap buyer? A) Prefers flexible, short-term interest rate B) Generally has a higher credit rating C) Often has a positive duration D) Generally has a large holding of short-term assets E) All of the above

Q: What is the objective of a cash flow hedge? A) To offset the losses due to changes in the value of an asset or liability B) To reduce the risk associated with future cash flows C) To maximize future cash flows D) To maximize the value of an asset or minimize the value of a liability E) None of the above

Q: For an all equity firm, A. As earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by the same percent B. As EBIT increases, the EPS increases by a larger percent C. As EBIT increases, the EPS decreases D. None of the above

Q: For a levered firm, A. As earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by the same percent B. As EBIT increases, the EPS increases by a larger percent C. As EBIT increases, the EPS decreases D. None of the above

Q: What is the objective of a fair value hedge? A) To offset the losses due to changes in the value of an asset or liability B) To reduce the risk associated with future cash flows C) To maximize future cash flows D) To maximize the value of an asset or minimize the value of a liability E) None of the above

Q: Capital structure is irrelevant if: A. the capital markets are perfect B. each investor holds a fully diversified portfolio C. each investor holds the same proportion of debt and equity of the firm D. all of the above

Q: Which of the following is one of the risks the OCC requires banks to measure and set limits on? A) Strategic risk B) Reputation risk C) Price risk D) Liquidity risk E) All of the above

Q: The law of conservation of value implies that: I) the mix of common stock and preferred stock does not affect the value of the firm II) the mix of long-term and short-term debt does not affect the value of the firm III) the mix of secured and unsecured debt does not affect the value of the firm A. I only B. II only C. III only D. I, II, and III

Q: What type of futures contract tends to accurately predict the consensus opinion as to actions to be taken by the Federal Open Market Committee in the future? A) U.S. Treasury Bond futures contract B) Eurodollar time deposit futures contract C) One month LIBOR futures contract D) Federal Funds futures contract E) All of the above

Q: The law of conservation of value implies that: I) the mix of senior and subordinated debt does not affect the value of the firm II) the mix of convertible and non-convertible debt does not affect the value of the firm III) the mix of common stock and preferred stock does not affect the value of the firm A. I only B. II only C. III only D. I, II, and III

Q: "Value additivity" works for: I) combining assets II) splitting up of assets III) mix of debt securities issued by the firm A. I only B. II only C. I and II only D. I, II, and III

Q: The Kromwell Community Bank has an average duration for its asset portfolio of 6 years. It also has an average duration for its liability portfolio of 2.5 years. This bank has $ $500 million in total assets and $450 million in liabilities. The Kromwell Community Bank is thinking about hedging their risk by using a Treasury Bond futures contract with a duration of 7.5 years and a price of $98,000. How many futures contracts will the Kromwell Community Bank need use to hedge their risk? A) 2381 contracts B) 2551 contracts C) 3061 contracts D) 4464 contracts E) None of the above

Q: If an individual wanted to borrow with limited liability he/she should: A. Invest in the equity of an unlevered firm B. Borrow on his/her own account C. Invest in the equity of a levered firm D. Invest in a risk-free asset like T-bills

Q: Julie Wells has found a Treasury Bond futures contract that has a duration of 8.5 years and is currently selling for $97,500. Interest rates are currently 8% and are expected to rise 1.5%. What is the change in this future contracts price for this change in interest rates? A) $1462.50 B) $12,431.25 C) -$11,521.42 D) -$1462.50 E) -$12,431.25

Q: An investor can undo the effect of leverage on his/her own account by: I) investing in the equity of a levered firm II) by borrowing on his/her own account III) by investing in risk-free debt like T-bills A. I only B. II only C. III only D. I and III above

Q: The amount of initial margin, the settlement price and other rules regarding trading futures contract are determined by: A) SEC B) Floor brokers C) Dealers D) Open interest E) Clearinghouse

Q: The law of conservation of value implies that: A. The value of a firm's common stock is unchanged when debt is added to its capital structure B. The value of any asset is preserved regardless of the nature of the claims against it C. The value of a firm's debt is unchanged when common stock is added to its capital structure D. None of the above

Q: The number of contracts that have been established and not yet offset or exercised is called by the Wall Street Journal. A) Initial margin B) Floor broker C) Settlement price D) Open interest E) Clearinghouse

Q: If an investor buys "a" proportion of the equity of a levered firm (firm L) then his/her payoff is: A. (a) (profits) B. (a) (interest) C. (a) * (profits - interest) D. none of the above

Q: When contracts are marked to market at the end of each day, the amount that is used to determine this is called the: A) Initial margin B) Floor broker C) Settlement price D) Open interest E) Clearinghouse

Q: If an investor buys "a" proportion of an both debt and equity of a levered firm (firm L) then his/her payoff is: A. (a) * (profits) B. (a) (interest) C. (a) (profits - interest) D. none of the above

Q: The person who executes orders in the futures market for the public is called the: A) Day trader B) Floor broker C) Bank examiner D) Speculator E) Scalper

Q: If an investor buys "a" proportion of an unlevered firm's (firm U) equity then his/her payoff is: A. (a) * (profits) B. (a) (interest) C. (a) (profits - interest) D. none of the above

Q: When an investor first purchases or sells a futures contract, she must make a deposit to the exchange. This is called the: A) Initial margin B) Floor broker C) Settlement price D) Open interest E) Clearinghouse

Q: If firm U is unlevered and firm L is levered, then which of the following is true: I) VU = EU II) VL = EL + DL III) VL = EU + DL A. I only B. I and II only C. I, II, and III D. III only

Q: The floating-rate payer in a swap may want to buy an interest-rate: A) Floor B) Cap C) Collar D) Option E) Neither a floor nor a cap

Q: An investor can create the effect of leverage on his/her account by: I) buying equity of an unlevered firm II) by investing in risk-free debt like T-bills III) by borrowing on his/her own account A. I only B. II only C. III only D. I and III only

Q: A bank with a duration gap of 2 years and total assets of $100 million uses a futures contract with a duration of .5 years and a price of $100,000 to hedge. The number of contracts that are needed is: A) 2000 B) 4000 C) 8000 D) 10,000 E) 20,000

Q: Modigliani and Miller's Proposition I states that: A. The market value of any firm is independent of its capital structure B. The market value of a firm's debt is independent of its capital structure C. The market value of a firm's common stock is independent of its capital structure D. None of the above

Q: All of the following interest-rate futures contracts are traded on exchanges except: A) Eurodollar futures contract B) Treasury Bond futures contract C) Eurodollar time deposit futures contract D) Federal Funds futures contract E) Corporate Bond futures contract

Q: A policy of maximizing the value of the firm is the same as a policy of maximizing the shareholders' wealth rests on two important assumptions. They are: I) the firm can ignore dividend policy II) the debt equity ratio of the firm does not change III) an issue of new debt does not affect the market value of existing debt A. I only B. II only C. III only D. I and III only

Q: The approximate percentage of banks who reportedly use derivative contracts is: A) 12% B) 25% C) 50% D) 75% E) 100%

Q: Under what conditions would a policy of maximizing the value of the firm not the same as a policy of maximizing shareholders' wealth? A. If the issue of debt increases the probability of bankruptcy B. If the firm issues debt for the first time C. If the beta of equity is positive D. If an issue of debt affects the market value of existing debt

Q: Interest rate caps: A) First developed in the 1980s B) Are one of the oldest interest rate hedging devices C) Allow for the exchange of different currencies by two parties D) Protect lenders from falling interest rates E) B and D above

Q: If a firm is financed with both debt and equity, the firm's equity is known as: A. unlevered equity B. levered equity C. preferred equity D. none of the above

Q: Interest rate swaps: A) First developed in the 1980s B) Are one of the oldest interest rate hedging devices C) Allows for the exchange of different currencies by two parties D) Are rigid and inflexible E) Are none of the above

Q: The total market value (V) of the securities of a firm with both debt (D) and equity (E) is: A. V = D - E B. V = E - D C. V = D E D. V = D + E

Q: Which of the following is a disadvantage of an interest rate swap agreement? A) Basis risk B) High brokerage fees C) Default risk D) Interest rate risk E) All of the above are disadvantages of interest rate swap agreements.

Q: Capital structure of the firm can be defined as: I) the firm's debt-equity ratio II) the firm's mix of different securities used to finance assets III) the market imperfection that the firm's manager can exploit A. I only B. II only C. III only D. I, II, and III

Q: Which of the following is an advantage of an interest rate swap agreement? A) Little or no basis risk B) Low brokerage fees C) Increased flexibility over other hedging techniques D) Little or no credit risk E) All of the above are advantages of interest rate swap agreements.

Q: When a firm has no debt, then such a firm is known as: I) an unlevered firm II) a levered firm III) an all-equity firm A. I only B. II only C. III only D. I and III only

Q: An agreement where a party with a lower credit rating enters into an agreement to exchange interest payments with a borrower having a higher credit rating is know as: A) An interest rate swap B) A currency swap C) A swaption D) A quality swap E) None of the above

Q: Explain why the cost of equity and the cost of debt are concave upward at high levels of debt.

Q: The part of an agreement which allows one or both parties to make certain changes to the agreement or eliminate the agreement is called: A) An interest rate swap B) A currency swap C) A swaption D) A quality swap E) None of the above

Q: State the generalized version of Modigliani-Miller proposition I.

Q: An agreement where two parties agree to exchange different currencies is known as: A) An interest rate swap B) A currency swap C) A swaption D) A quality swap E) None of the above

Q: Discuss a successful example of corporations trying to add value through innovative financing.

Q: An interest rate collar: A) Combines a rate floor and a rate cap into one agreement. B) Ranges in maturity from a few days to a few weeks. C) Protects a lender from rising interest rates. D) All of the above. E) B and C only.

Q: Under what circumstances would MM's proposition is violated? Briefly discuss.

Q: An interest rate swap is: A) A way to change a bank's exposure to interest rate fluctuations. B) A way to achieve lower borrowing costs. C) A way to convert from fixed rates to floating rates. D) A way to transform actual cash flows through the bank to more closely match desired cash flow patterns. E) All of the above.

Q: A retiree believes that investing in a non-dividend paying growth firm, that requires the periodic sale of stock for income, will eventually lead to a loss of all shares. Explain the flaw in this logic.

Q: Interest rate hedging devices used by banks today include which of the following: A) Financial futures contracts. B) Interest-rate options contracts. C) Interest rate swaps. D) Interest rate caps, floors, and collars. E) All of the above.