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Finance 3101 Exam 1 Review: Chapters 1-5 with Actual Test, Exams of Finance

A comprehensive review of key concepts covered in chapters 1-5 of finance 3101, including the cycle of money, financial markets, financial management, corporate governance, and financial statements. It features multiple-choice questions with correct answers, offering valuable practice for students preparing for their first exam.

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2024/2025

Available from 11/19/2024

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Finance 3101, Howard Keen, Exam 1
Review (Chapters 1-5) with Actual Test
A+ Graded
1. Describe the cycle of money, the participants in the cycle, and the
common objective of borrowing and lending. - Correct Ans: ✔✔The
cycle of money is the movement of money from lender to borrower
and back again. It is often accomplished through a financial
intermediary like a bank. The common objective is to make both the
lender and the borrower better off.
2. Distinguish the four main areas of finance and briefly explain the
financial activities that each encompasses. - Correct Ans: ✔✔The
four main areas of finance are corporate finance, investments,
financial institutions and markets, and international finance.
3. Corporate Finance - Correct Ans: ✔✔Supports the operations of a
company.
4. Investments - Correct Ans: ✔✔Are the activities centered on buying
and selling stocks and bonds.
5. Financial Institutions and Markets - Correct Ans: ✔✔Are the
organizations that promote the cycle of money and the buying and
selling of financial assets.
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Finance 3101, Howard Keen, Exam 1

Review (Chapters 1-5) with Actual Test

A+ Graded

  1. Describe the cycle of money, the participants in the cycle, and the common objective of borrowing and lending. - Correct Ans: ✔✔The cycle of money is the movement of money from lender to borrower and back again. It is often accomplished through a financial intermediary like a bank. The common objective is to make both the lender and the borrower better off.
  2. Distinguish the four main areas of finance and briefly explain the financial activities that each encompasses. - Correct Ans: ✔✔The four main areas of finance are corporate finance, investments, financial institutions and markets, and international finance.
  3. Corporate Finance - Correct Ans: ✔✔Supports the operations of a company.
  4. Investments - Correct Ans: ✔✔Are the activities centered on buying and selling stocks and bonds.
  5. Financial Institutions and Markets - Correct Ans: ✔✔Are the organizations that promote the cycle of money and the buying and selling of financial assets.
  1. International Finance - Correct Ans: ✔✔Is concerned with the multinational element of finance activities.
  2. Explain the different ways of classifying financial markets. - Correct Ans: ✔✔There are a number of ways to classify financial markets: by type of asset traded, by maturity of assets, by owner of the assets, or by method of sale.
  3. Discuss the three main categories of financial management. - Correct Ans: ✔✔Financial management can be subdivided into three categories: capital budgeting, capital structure, and working capital management.
  4. Capital Budgeting - Correct Ans: ✔✔Is the process of choosing the products and services the company will produce.
  5. Capital Structure - Correct Ans: ✔✔Is concerned with choosing the lenders the company will use to finance its operations.
  6. Working Capital Management - Correct Ans: ✔✔Involves choosing the policies that manage day-to-day operating needs of the company.
  1. Illustrate agency theory and the principal-agent problem. - Correct Ans: ✔✔Companies run by managers who may have different goals than the owners. The resolution of these potential problems is the domain of agency theory. The principal-agent problem is the conflict between the owners of the company and the managers hired by the owners to work in the owners' best interests.
  2. Review issues in corporate governance and business ethics. - Correct Ans: ✔✔Corporate governance deals with how a company conducts its business and what controls are put in place to ensure proper procedures and ethical behavior. Although many managers and owners operate in an ethical manner, some do not. The government may add rules and regulations about the conduct of business and its officers to encourage ethical and honest behavior.
  3. Explain the foundations of the balance sheet and income statement. - Correct Ans: ✔✔There are four financial statements that report the performance of a firm: (1) the balance sheet, (2) the income statement, (3) the statement of retained earnings, and (4) the statement of cash flow. In this chapter, we examined the four financial statements and the connections between each of the four statements with particular interest in the sources and uses of cash. In finance we are generally concerned with how a company is generating cash and where the company is spending cash.
  4. Use the cash flow identity to explain cash flow. - Correct Ans: ✔✔The cash flow identity simply states that the cash from assets is always equal to the cash to lenders and the cash to owners. Put

another way, it allows a financier to reconstruct the balance sheet and income statement accounts to show where cash was generated and where cash was used during a particular time period.

  1. Provide some context for financial reporting. - Correct Ans: ✔✔All public firms are required by law to submit annual (10-K) and quarterly (10-Q) performance reports to the U.S. Securities and Exchanges Commission. Regulation fair disclosure requires that information be released to the public and not to special groups or individuals. The notes to the financial statements often provide a rich store of information about how the statements were constructed or more commentary that is relevant to the future operations of the company.
  2. Recognize and view Internet sites that provide financial information. - Correct Ans: ✔✔The Internet has many sites that provide financial statements as well as other significant information about publicly traded firms. Not all sites are free or comprehensive. In addition, the formatting of financial data is not always consistent across different sites. Sometimes it is necessary to dig through the financial statements to get the information necessary to examine the performance of a firm.
  3. Accounting Identity: Assets - Correct Ans: ✔✔Liabilities+Owners' Equity
  1. Calculate present values and understand discounting. - Correct Ans: ✔✔Present value is the value today of tomorrow's cash flow. You can determine the equivalent value of a future value in today's dollars by discounting the future value back to the present.
  2. Calculate implied interest rates and waiting time from the time value of money equation. - Correct Ans: ✔✔The time value of money equation is robust in that it can be arranged to find each of the four different variables (future value, present value, waiting time or time to maturity, and interest rate) and thus answer a series of different questions. To find the interest rate, you need the present value, the future value, and the number of periods. To find the waiting time, you need the present value, the future value, and the interest rate.
  3. Explain the Rule of 72, a simple estimation of doubling values. - Correct Ans: ✔✔The Rule of 72 allows you to determine how long it takes to double your money at a specific interest rate. It is a simple approximation method in which 72 is divided by the interest rate to find the number of years it takes to double your money.
  4. FV (Future Value) - Correct Ans: ✔✔PV x (1+r)^n
  5. PV (Present Value) - Correct Ans: ✔✔FV x 1/(1+r)^n
  1. r (Interest Rate, Growth Rate, Discount Rate) - Correct Ans: ✔✔(FV/PV)^l/n- 1
  2. n (Number of Time Periods; Waiting Period) - Correct Ans: ✔✔ln (FV/PV)/ln (1+r)
  3. Compute the future value of multiple cash flows. - Correct Ans: ✔✔To obtain the future value of multiple payment streams, bring all the cash flows to the same point in time and add them together with their accumulated interest.
  4. Determine the future value of an annuity. - Correct Ans: ✔✔An annuity is a series of equal cash payments at regular intervals across time. The future value of an annuity can be determined by multiplying the payment or deposit by the factor [(1+r)^n-1]/r, where r is the interest rate and n is the number of payments. This factor is known as the future value interest factor of an annuity.
  5. Determine the present value of an annuity. - Correct Ans: ✔✔The present value of an annuity can be determined by multiplying the payment or deposit by the factor [1-1/(1+r)^n]/r, where r is the interest rate and n the number of payments. This factor is known as the present value interest factor of an annuity.
  6. Adjust the annuity formula for present value and future value for an annuity due and understand the concept of a perpetuity. -
  1. Calculate waiting time and interest rates for an annuity. - Correct Ans: ✔✔Rearranging the FV or PV of an annuity equation can isolate the variable n so that you can solve directly for the waiting time. You cannot isolate the variable r (interest rate), however, so you must either go through an iterative process or use a calculator or spreadsheet to solve for it.
  2. Apply the time value of money concepts to evaluate the lottery cash flow choice. - Correct Ans: ✔✔The time value of money equations can be used to determine the implied interest rate between two lottery pay-off options of an annuity stream or a lump- sum payment. This information is not sufficient to determine the optimal choice between the two pay-off options but can provide valuable information about the implied trade-offs between the two choices.
  3. Summarize the ten essential points about the time value of money. - Correct Ans: ✔✔The ten key points include the fact that amounts of money can be added or subtracted only if they are at the same point in time. So not all important data can be classified into the variables of present value, time, interest rate, payment, and future value.
  4. FV - Correct Ans: ✔✔PMT x (1+r)^n-1/r
  5. PV - Correct Ans: ✔✔PMT x 1-1/(1+r)^n/r
  1. PV - Correct Ans: ✔✔PMT/r
  2. PMT - Correct Ans: ✔✔PV/1-[1/(1+r)^n]/r
  3. n - Correct Ans: ✔✔ln ( (FV x r)/PMT+1) )/ln (1+r)
  4. Discuss how financial institutions quote and compute the effective annual rate on a loan or investment. - Correct Ans: ✔✔Advertised interest rates; also called annual percentage rates (APRs) are stated on an annual basis and are nominal interest rates. A nominal rate is one that has been adjusted for inflation when compared with the real rate of interest. Interest rates can be applied annually, semiannually, quarterly, monthly, weekly, or even daily. These rates are periodic interest rates: the APR divided by the number of compounding periods per year. The effective annual rate (EAR) is the rate of interest actually paid or earned per year and depends on the number of compounding periods. It gives the best information on the cost of the loan or yield on an investment because it takes into account the interest earned on interest. It is the APR adjusted for compounding.
  5. Apply the time value of money equation by accounting for the compounding periods per year. - Correct Ans: ✔✔The time value of money equation uses the periodic interest rate. To use this equation properly, it is essential to know the umber of compounding periods

default premium. Second is the maturity premium, which accounts for the length of the loan. The longer the borrower will take to pay back the loan, the greater the maturity premium. These two premiums account for the major differences in rates across different investments and loans.

  1. Understand the implications of the yield curves. - Correct Ans: ✔✔Interest rates vary based on the maturity date of a bond or loan. Typically the longer a borrower takes to repay a loan, the higher the interest rate. When we plot this concept on a graph with time to maturity on the x-axis and interest rates on the y-axis, we see an upward-sloping yield curve. We use the yield curve as a benchmark for the current rates in the market. Economists use the curve to predict changes in future interest rates, economic output, and growth.
  2. Periodic Interest Rate, r - Correct Ans: ✔✔APR/m
  3. EAR - Correct Ans: ✔✔(1+APR/m)^m- 1
  4. (1+r) - Correct Ans: ✔✔(1+r*) x (1+h)
  5. r - Correct Ans: ✔✔r+h+(rxh)
  6. r - Correct Ans: ✔✔r*+h+dp+mp
  1. r* - Correct Ans: ✔✔Real Rate of Interest
  2. dp - Correct Ans: ✔✔Default Premium
  3. mp - Correct Ans: ✔✔Maturity Premium
  4. h - Correct Ans: ✔✔Inflation
  5. EAR - Correct Ans: ✔✔Effective Annual Rate
  6. m - Correct Ans: ✔✔Number of Compounding Periods Per Year