finance (minor) final exam review spring 2014

8/11/2019 Finance (Minor) Final Exam Review Spring 2014

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TEST REVIEW QUESTIONSFINAL EXAM -- SPRING 2014

1. How does your credit score impact getting a mortgage loan?a. No loan

b. Loan with high IR (similar to subprime mortgage) 2. What are the causes of general inflation?a. Price goes up without improvement in quality b. Demand exceeds Supply

3. How does leverage impact investments?a. IR lower than rate of return on investment increased returns b. IR higher than rate of return on investment increased loss

4. How do supply/demand impact interest rates according to the loanable fundstheory?

a. Supply increase and Demand stable IR goes down b. Supply decrease and Demand stable IR goes up

c. Supply stable and Demand increase IR goes up d. Supply stable and Demand decrease IR goes down

5. What is the nominal interest rate (r)?a. Nominal interest rate - Market Interest Rate

6. What is the real rate of interest (RR)?a. Real rate of interest - Risk-free rate with no inflation expected b. Question US govt bond not true? Govt bonds do not have RR factor

7. What is inflation premium (IP)?a. Inflation premium average inflation rate expected over the life of the loan

8. What is default risk premium (DRP)?a. Compensation for risk of non-payment b. Corporate Bond and Government bond (same duration) IR difference d/t

DRP i. Govt bond = no DRP

ii. DRP is 2% on corporate bonds 9. What is maturity risk premium (MRP)?

a. Added return to compensate for opportunity cost of possible future IRincreases

b. Question Not true about MRP? Answer None of the above (all are true) i. MRP represents returns required to compensate for opportunity

costs ii. Higher on longer bonds

iii. MRP will decrease as bond approaches its maturity date 10. What is liquidity premium (LP)?

a. Added return if debt instrument is not easily turned into cash (for obscurebonds)

11. What is the IMF?a. Answer All the Above b. Created to promote world trade through monitoring and maintaining fixed

exchange rates and making loans to countries with trade imbalances


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12. What does the Export-Import Bank do?a. US agency designed to assist international trade

i. Promote trade/export with the USb. Loans made to foreign countries and governments to buy US goods

13. How does balance of trade impact exchange rates?

a. Out of balance (negative) trade Exchange rates Increase 14. How do countries benefit from imports/exports?a. International trade

i. Lowers costs ii. Provides expanded markets for US goods

iii. Does NOT help strengthen our dollar (not answer) b. If International trade was eliminated

i. Producers would see decreased markets ii. Consumers would pay more for products such as clothing, furniture,

etc.) iii. Answer A and B

15. What is the Social Security Trust Fund?a. Answer - It will be liquidated over time

i. Has a limited trust fund that will cover shortfalls of contributionsonly through the year 2033 (at which time, benefits would have tobe reduced to 75% of historical levels)

16. What are types of fuels used for electric generation? Which are cheapest?a. Answer Coal is the most polluting fuel

17. What are benefits of outsourcing?a. Allows company to focus on core competencies b. Provides access to greater expertise c. Provides flexibility to labor force

18. What are drawbacks of outsourcing?a. Contracting work out to an external organization No expertise internally

19. What are benefits of off-shoring?a. Takes advantage of lower wage rates and skill levels in other countries

i. Cheaper labor ii. Better skilled (highly educated i.e. technical support)

20. What are risks associated with off-shoring?a. Contracting work out to be performed in a foreign country

i. Communication barrier ii. Must address Ethical Issues

iii. Risks and instabilities in Foreign country 21. What is a Ponzi scheme?

a. Funds from new investors are used to pay returns to existing investors(under pretext that those returns are investment earnings)

b. Money from 1 investor is given to another investor (looks like a return) 22. What did Bernie Madoff do?

a. Most famous Ponzi scheme (15% returns) that lasted for 20 years b. Earned 50 billion dollars from investors

23. What did Martha Stewart do?


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a. Had inside information and lied to the SEC sent to prison b. Sold 4000 shares to save $46,000

24. What is insider trading?a. When one acts on specific information that has not been made public yet,

providing an unfair advantage

25. What is a call provision on a bond?a. Buy back at par/face value b. Question Why would an issue want to have a call provision on his bond?

Answer B and C i. In the event IR decreases

ii. In the event he wants to reduce outstanding debt 26. What are zero coupon bonds?

a. Pay zero interest b. Answer:

i. Purchased at below par value ii. Could have tax advantage over coupon bonds (Possibility of a tax

benefit) 27. What is impact of a stock split?

a. Twice as many shares at half the price (investment still the same) b. Answers:

i. Makes it easier for new investors to purchase stock ii. More shares and lowers the price

iii. Increase value to shareholders (NO!)iv. Increases dividend payouts (NO!)

28. What type of mutual funds would you expect to have high expense ratios?a. Small Cap Growth Fund b. Question What would you expect from a small cap group mutual fund?

i. Higher beta than large cap value mutual fund ii. Higher expense ratio than a large cap mutual fund

iii. Answer - C 29. What type of mutual funds would you expect to have low expense ratios?

a. Bond Mutual Funds or Large Cap Mutual Funds (fewer stocks) 30. What can you assume about a mutual fund based on its beta?

a. Beta 1= follows the market b. Beta 1?

i. If the overall market goes down, you expect stock prices to go downmore than the market

31. When evaluating mutual funds, why should you look at anything other than themost recent year's performance?

a. Want to see long term trend b. See how it performs in a different economic time (esp. times of economic

difficulties) c. 1 year could be a fluke


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32. What is systematic risk?a. Applies to all stocks b. Question What is systematic risk?

i. Cannot be reduced by diversification 33. What is unsystematic risk?

a. Question Why should you diversity your investments? i. Answer: Reduces unsystematic risks b. Question What is unsystematic risk?

i. Risk that can be reduced by diversification ii. Risk that is specific to individual stocks

iii. Answer: D

34. Why should you always have adequate federal income tax withheld from yourpaycheck?

a. Dont want to come up with an unexpected dollar amount come April 15 b. Dont have to worry about spending it (the money withheld) Keeps you

from spending itc. Dont want to owe the Federal Govt anything d. Awesome when you get tax refund!

35. Why should you always pay off the full balance of your credit cards?a. Because IR is unbelievably highb. Easy to get into the trap and hard to get out of

36. What is a recurring non-recurring item?a. Stuff always happens b. Non-recurring items (things that happen one time) recur all the time

37. Why should you not buy ordinary life insurance?a. Separate out your Life insurance needs from your investments

i. Do investments through your 401K (retirement) ii. Buy Term Life Policy less expensive

iii. There will be a point in time when you dont need life insuranceanymore

38. How much insurance should you have?a. As little as possible b. Only insure the things you cannot afford to lose (e.g. House, Life,

Disabilities) c. Maximize deductible provided you have savings to cover Take the highest

deductible you can afford to cover 39. What is benefit of having a portion of your paycheck directly deposited to you

savings account?a. If you dont see it, you will not spend it! b. No-budget budget you can spend whatever money you have in the bank

(wont see savings) 40. When should you rent rather than buy a house?

a. Rent if you think that a job move may be requires in less than 4 years i. Get stable and them buy a house


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ii. Having to sell a house can limit your ability to accept a better job inanother city

1. House in not a liquid investment iii. Exception if move is with company that covers moving costs

41. What is the benefit of a "no-budget budget plan"?

a. Benefit Doesnt requires keeping track of individual expenditures b. Need to have adequate withholding, emergency fund, etc. whatever isleft is there for you to spend it

42. What is drawback of a detailed budget plan?a. Drawback Can be very time consuming and requires constant monitoring

of expenditures b. Have to keep track of things c. See how youre doing relative to your budget and see if you need to make

any adjustments to it 43. What are critical considerations in preparing a detailed budget plan?

a. Determine what individual expense breakouts you want to detail

b. Determine timing of big item payments c. Be realistic/conservative d. Dont forget about inflation!!! e. Provide contingencies f. Review and make adjustments when needed g. Note:

i. You do not have to keep track of every little bitty expenditure, youcan group them.

ii. Need to know when the big expenditures are coming in 44. What factors are considered in determining individual health insurance policy

rates?a. Individuals age, medical history, and regional demographics determine

rates b. Questions Prior to implementation of Obamacare, individual healthcare

policies i. Answer: had premiums based on individual age and medical history

45. What were purposes behind Obamacare?a. Decrease number of uninsured Americans b. Reduce overall costs of healthcare c. Improve healthcare outcomes and streamline delivery of healthcare d. Requires insurance companies to cover all applicants and offer same rates

regardless of pre-existing conditions or gender e. Question What is not a feature of Obamacare?

i. Answer: All businesses must provide healthcare coverage for allemployees

f. Question What is not a feature of Obamacare? i. Answer: Small businesses will have all premiums for employees

subsidized for 2 years 46. What is the individual mandate?

a. Individuals must purchase insurance or pay penalty


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47. What are health insurance exchanges?a. Establishes health insurance exchanges by state as marketplace for

individuals and small businesses b. Insurance companies put on the internet what their rates are

48. What is impact of expanding Medicaid to individuals and families up to 133% of

poverty level?a. State administers Medicaid and have to pay for it b. To encourages states to cover Medicaid, the federal government will pay

100% of any additional cost the state incurs by expanding the Medicaid upto 133% for the first 2 years

i. Govt will pay 90% thereafterii. Some states chose not to expand

c. Question how are subsidies funded for low-income? i. Encourage states to fund Medicaid

ii. Raise taxes? 49. What is impact of Obamacare on companies with over 50 employees?

a. Question: Expected reactions of company to the implementation ofObamacare?

i. Answer: All the Above ii. Elect to discontinue providing healthcare with penalty

iii. Small companies try to keep the number of fulltime below 50 iv. Try to raise prices to cover additional healthcare costs

50. What is difference between hedging and speculation?a. Hedging

i. Seller of commodity wants to lock in price but doesnt want to becommitted in case price goes up substantially

ii. Buyer of commodity wants to lock in purchase price but isconcerned that prices could drop substantially

iii. To reduce riskb. Speculation

i. Seller, buyer, or speculator believes that option is mispriced andsees significant profit potential

ii. Speculator believes that prices will be higher/lower than listed priceand will buy/sell with hope of making profit

c. Hedging has the product to back it up, Speculation does not have theproduct to back it up

51. Why would seller want to hedge?a. Seller of commodity wants to lock in price for future months rather than

taking risk on future spot pricesi. May want to lock in profit

ii. May think that prices could go down in future below availablefutures price

iii. May be required to lock in by lender/bankerb. He believes theres a good price out there in the Future s Market

52. Why would buyer want to hedge?


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a. Buyer of commodity wants to lock in purchase price for future needs ratherthan taking risk on future spot price

i. May want to lock in profit on finished productii. May think that prices could go up in future above available future

price

iii. May be required to lock in lenders/bankerb. Thinks he can get hurt if the prices go way up

Producer Manufacture SpeculatorHedging Sells

FuturesCont.

Buy FuturesCont.

Rather than waiting onspot market to reducerisk

Speculation Buy Sell Believe the pricing isoff/try to make moneythinking its a bargain

Sells/BuysFuture Cont.

Speculator middle m an, doesnt produce/manufacture the product, always speculating,never hedging because he doesnt have the product to back it up Question Who buys Future?

Answer: Manufacture with commodity and speculators .and producers??

53. What is an options contract?a. Contract with right, but with no obligation, to buy or sell an asset at a

specified price prior to a specified date54. What is the difference between a put and a call option?

a. Put Option Right to Sellb. Call Option Right to Purchase

55. Why would seller of a commodity want to purchase a put option?a. Gives them the right (not the obligation) to sell an asset at a specific price

by a predetermined date to a given party used to protect against thedecline of the price of the commodity

i. The buyer is obligated to buy the commodity at the strike price56. Why would a buyer of a commodity want to purchase a call option?

a. Gives them the right (not the obligation) to buy an asset from the seller ofthe option at a certain time for a certain price

i. The seller is obligated to sell the commodity to the buyer if thebuyer decides so.

57. How are futures contracts priced?a. Inflation Factorb. Interest Rate Factorc. Seasonal Factord. Business Factore. Based on the Market half the people think its going to go up, half think its

going to go down 58. How are Option contracts priced?


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a. Volatility Factorb. Inflation Factorc. Interest Rate Factord. Business Factore. Black- Scholes Model

f. Calculated on the basis of the Black-Scholes Model 59. What are possible solutions to fix the Social Security system?a. Raise SS taxes, Raise limit on which SS taxes apply, change calculation of

COLA, increase eligibility age, and Means Testing b. Questions Which is less likely to cure SS Trust Fund?

i. Answer Less likely to raise/change Taxes 60. How is the front-end ratio calculated? Back-end ratio?

a. Front End Ratioi. Annual Salary X 30%/12 = Maximum Monthly Housing Expense

ii. Pretax Incomeiii. Monthly Housing Expenses interest, principle, property taxes,

mortgage insurance, HOA dues, and homeowners insurance b. Back End Ratio

i. Annual Salary X 45%/12 = Maximum Allowable Debt-to-IncomeRatio

ii. Pretax Incomeiii. Monthly Payment Obligations Mortgages, other loans, child

support, credit card payments, car payments, and installment loans61. What are possible impacts of increase in the minimum wage rate?

a. Not on test

62. What are features of sub-prime mortgages?a. Question:

i. Higher IR than prime mortgages ii. Higher likelihood of default

iii. They are marketable 63. What were causes of financial crisis in 2008?

a. Credit Default Swaps and loosen the credit standards, housing market andraise in credit

b. Question What was NOT as a cause of the financial crisis in 2008? i. Answer Bankruptcy of the FDIC

64. What are factors affecting the valuation of stocks?a. Question

i. Domestic and global economic conditions (systematic risks) ii. Sales Growth

iii. Answer: A and B 1. Has nothing to do with the comparison of stock prices

between competition 65. What does a Morningstar rating indicate?

a. Number of Stars (5 max) are comparing that fund to other similar funds insimilar styles


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66. What securities may be included in money market funds?a. Money market funds are short term (

finance (minor) final exam review spring 2014

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