C214 Financial Management Practice Questions - Set 5 - Part 2

Correct Answer: They are inversely related

Bond prices and interest rates move inversely; when interest rates rise, bond prices fall, and when interest rates fall, bond prices rise.

Correct Answer: Revenues are matched with the expenses incurred to generate them

The matching principle ensures that revenues and the expenses incurred to generate them are recorded in the same period, providing a more accurate picture of profitability.

Correct Answer: Market risk premium

The market risk premium represents the additional return that investors demand for taking on the higher risk associated with investing in the stock market compared to risk-free assets.

Correct Answer: Risk that affects the entire market

Systematic risk, also known as market risk, affects the entire market and cannot be eliminated through diversification, unlike idiosyncratic risk.

Correct Answer: Balance sheet

The balance sheet provides a snapshot of a company’s financial position, detailing its assets, liabilities, and shareholders' equity at a specific point in time.

Correct Answer: Preferred stock has priority over common stock in bankruptcy

In the event of bankruptcy, preferred stockholders have a higher claim on assets and earnings than common stockholders, making it a safer investment.

Correct Answer: The required return on both debt and equity

The cost of capital represents the return that a company must earn to meet the expectations of its debt and equity holders, reflecting the company’s overall financing cost.

Correct Answer: Return on equity (ROE)

Return on equity (ROE) measures a company’s ability to generate profits from its shareholders' equity, indicating how effectively the company is using its equity to generate returns.

Correct Answer: It increases the company’s risk

Higher financial leverage means the company is using more debt to finance its operations, which increases the risk of bankruptcy if the company cannot meet its debt obligations.

Correct Answer: To assess a company’s liquidity without relying on inventory

The quick ratio measures a company’s ability to meet short-term obligations using only its most liquid assets, excluding inventory, which may not be easily converted to cash.

Correct Answer: The expected return on an asset, considering its risk

CAPM helps investors determine the expected return on an asset by accounting for both the risk-free rate and the asset’s risk, using the asset’s beta to measure its market risk.

Correct Answer: The growth rate achievable without external funding

The sustainable growth rate (SGR) is the maximum growth a firm can achieve without needing additional external funding, based solely on internal operations and retained earnings.

Correct Answer: Credit risk

Credit risk is the risk that the bond issuer may default on interest payments or fail to repay the principal, which is a significant concern for bondholders.

Correct Answer: Return on assets (ROA)

Return on assets (ROA) measures a company’s profitability by comparing net income to total assets, providing insight into how effectively the company is using its assets to generate profit.

Correct Answer: To distribute cash to shareholders or reinvest in the business

Free cash flow (FCF) represents the cash that remains after a company has covered its operating expenses and capital expenditures, which can be used to pay dividends, repurchase stock, or reinvest in the business.

Correct Answer: The bond’s total return if held to maturity

Yield to maturity (YTM) represents the total return that a bondholder can expect if they hold the bond until maturity, considering both interest payments and the repayment of the bond’s face value.

Correct Answer: To monitor risks to the U.S. financial system

The Financial Stability Oversight Council (FSOC) monitors risks to the U.S. financial system, particularly those posed by large financial institutions, to prevent economic instability.

Correct Answer: To determine the rate of return on a project, setting the net present value (NPV) to zero

Internal rate of return (IRR) is used in capital budgeting to determine the rate of return at which the net present value (NPV) of an investment is zero, helping to evaluate whether a project is worth pursuing.

Correct Answer: The firm’s ability to meet short-term liabilities

The current ratio measures a firm’s ability to pay off its short-term liabilities with its current assets, providing insight into the firm’s liquidity position.

Correct Answer: The asset is more volatile than the market

A high beta indicates that the asset is more volatile than the overall market, meaning it carries more risk but also offers the potential for higher returns.