Chapter 05

Multiple choice questions

1. An investment decision differs from a financing decision in that:

o A. An investment decision considers how the investments under

consideration are to be funded

o B. A financing decision first determines what assets the firm will

invest in

o C. An investment decision is concerned with the day-to-day

operations of the firm

o D. An investment decision first determines what assets the firm will

invest in, while a financing decision considers how the investments
under consideration are to be funded

2. When a company decides to issue an unsecured note to pay for a new

machine, it has made a/an:

o A. investment decision

o B. operational decision

o C. financing decision

o D. strategic decision

3. The finance required by a company to fund its day-to-day operations is

called:

o A. capital expenditure

o B. long-term financing

o C. equity capital

o D. working capital
4. When a company decides to pay for an investment project using a short-
term bank loan, this is best described as a/an:

o A. investment decision

o B. operational decision

o C. financing decision

o D. strategic decision

5. Which of the following statements is correct for an investment proposal

with a positive NPV?

o A. The IRR is less than the required rate of return

o B. The IRR is greater than the required rate of return

o C. The IRR is equal to the required rate of return

o D. The IRR is not related to the required rate of return

6. Problems associated with calculating an internal rate of return include:

o A. negative cash flows during the project’s lifetime

o B. choosing one project from two or more projects

o C. timing of cash flows

o D. All of the given answers

7. When a company’s project results in a return and profits which exceed the
cost of its debt borrowing:

o A. only the creditors may share in the profits

o B. only the shareholders may share in the profits

o C. both the creditors and shareholders may share in the profits

o D. neither the creditors nor the shareholders may share in the

profits
8. Financial risk refers to the:

o A. risk faced by the creditors when equity is used

o B. risk faced by the company when debt is used

o C. risk faced by the shareholders when debt is used

o D. risk faced by the company when equity is used

9. Increasing the financial leverage of a company will ____ shareholders’

expected returns and ____ their risk.

o A. decrease; decrease

o B. decrease; increase

o C. increase; increase

o D. increase; decrease

10.Which of the following statements about financial risk is incorrect?

o A. If a corporation imports goods from overseas then a depreciation

in the exchange rate will adversely affect the company’s profits

o B. If a corporation imports goods from overseas then an

appreciation in the exchange rate will adversely affect the
company’s profits

o C. If a corporation exports goods overseas then a depreciation in

the exchange rate will adversely affect the company’s profits

o D. If a corporation exports goods overseas then an appreciation in

the exchange rate will adversely affect the company’s profits

11.Which of the following statements about financial risk is incorrect?

o A. When a business fails, equity holders rank behind providers of

debt due to their higher financial risk
 o B. When a business fails, equity holders rank equally with
providers of debt due to their higher financial risk

o C. When a business fails, equity holders rank ahead of providers of

debt due to their higher financial risk

o D. When a business fails, equity holders rank behind providers of

debt due to their lower financial risk

12.A company’s business risk depends on:

o A. the risk of the company’s financial structure

o B. the risk of the company’s operations and assets

o C. the risk of the company’s market conditions

o D. the risk of the company’s management decisions

13.Which of the following criteria would be determinants of the appropriate

ratio of debt to equity if a company should not take on more debt than can
be serviced under conservative economic forecasts?
i. Maximisation of shareholder wealth
ii. Industry norms
iii. History of the ratio for the firm
iv. The stage of the current economic cycle
v. Limit imposed by lenders vi. The company's capacity to
service debt

o A. i, ii, iii, iv

o B. ii, iii, v, vi

o C. i, iii, iv, v

o D. i, ii, iv, vi

14.Restrictions placed on borrowers by lenders in the loan agreement are

called loan:
 o A. covenants

o B. conditions

o C. clauses

o D. commitments

15.An increase in a firm’s level of debt will:

o A. decrease the variability in earnings per share

o B. increase the variability in earnings per share

o C. have no effect on the variability in earnings per share

o D. stabilize the variability in earnings per share

16.Compared with retail sector companies, banks have a:

o A. low debt-to-equity ratio

o B. moderate debt-to-equity ratio

o C. high debt-to-equity ratio

o D. variable debt-to-equity ratio

17.The claims of the equity holders on the assets of the firm have priority
over those of:

o A. creditors

o B. bondholders

o C. preferred shareholders

o D. No other holder

18.Who are sometimes referred to as the residual owners of the corporation?

o A. The creditors

o B. The bondholders
 o C. The common shareholders

o D. The preferred shareholders

19.What is the function of a proxy statement for a shareholder?

o A. It gives them the right of a vote for each share they own

o B. It gives them the right to dividends

o C. It gives them the right to sell their shares

o D. It gives them the right to buy more shares

20.Which of the following statements is NOT a feature of ordinary shares?

o A. Ordinary shares represent ownership in the company

o B. Ordinary shares have voting rights

o C. Ordinary shares may receive dividends

o D. Dividends of ordinary shares are always tax deductible

21.Generally, an initial public offering is:

o A. an offer to potential investors of ordinary shares to newly list a

company on a stock exchange

o B. an offer to potential investors of bonds to newly list a company

on a stock exchange

o C. an offer to potential investors of preferred shares to newly list a

company on a stock exchange

o D. an offer to potential investors of debentures to newly list a

company on a stock exchange

22.Holders of equity capital:

o A. lend money to the company

o B. own the company

 o C. manage the company

o D. regulate the company

23.Common shareholders are:

o A. guaranteed a periodic distribution

o B. guaranteed a distribution in the wind-up of the company

o C. guaranteed both a periodic distribution and a distribution in the

wind-up of the company

o D. not guaranteed a periodic distribution or a distribution in the

wind-up of the company

24.Which of the following statements best describes the role or function of

the promoter of a flotation?

o A. The party underwriting the flotation of the company

o B. The party managing the flotation of the company

o C. The party seeking the flotation of the company

o D. The party regulating the flotation of the company

25.Potential investors learn of the information concerning the company and

its new issue by being sent a ____ by the broker.

o A. memorandum

o B. prospectus

o C. newsletter

o D. report

26.As part of the listing process for an unlisted organisation, a document that
provides detailed information on the past and forecast performance for it
is a:
 o A. memorandum

o B. prospectus

o C. newsletter

o D. report

27.When a company undertakes an initial public offering (IPO) it may:

o A. issue and list bonds in the primary bond market

o B. issue and list preferred shares in the primary share market

o C. issue and list shares in the primary share market

o D. issue and list debentures in the primary debt market

28.Compared with raising debt through a bank, the raising of equity through
an IPO is generally:

o A. cheaper

o B. dearer

o C. the same cost

o D. less risky

29.A financial institution involved in underwriting the sale of new securities

by buying them from the issuing firms and then reselling them to the
public in the primary capital market is an:

o A. commercial bank

o B. credit union

o C. insurance company

o D. investment banker

30.Which of the following is NOT a role of an underwriter in a public

offering of shares?
 o A. To assume the risk of buying the shares from the issuer

o B. To help set the initial offering price

o C. To invest the funds raised in the offering

o D. To sell the shares to the public

31.If, for an IPO, circumstances change and the issue becomes unattractive,
the underwriters:

o A. must cancel the IPO

o B. must proceed with the IPO regardless

o C. may purchase unsubscribed shares

o D. may return the shares to the issuing company

32.If, for an IPO, market prices have fallen, then underwriters with an out-
clause that gives a level of a specified price index that the index cannot
fall below, then:

o A. the underwriters must proceed with the IPO

o B. the underwriters must cancel the IPO

o C. the underwriters may be released from their obligations

o D. the underwriters must renegotiate the terms

33.Ordinary shares in limited liability companies are the major source of

external equity funding for Australian companies. Which of the following
statements regarding the issuance of ordinary shares by a newly listed
limited liability company is incorrect?

o A. Ordinary shares represent ownership in the company

o B. Ordinary shares have voting rights

o C. Ordinary shares may receive dividends

 o D. No liability company can issue shares only on a fully paid basis
because of the risk

34.Companies can raise equity capital through:

o A. issuing bonds

o B. taking out loans

o C. retained earnings and the share market

o D. selling assets

35.A person who is authorised to vote on a shareholder’s behalf is called:

o A. a trustee

o B. a proxy

o C. an agent

o D. a representative

36.Which of the following statements about a no liability company is

incorrect?

o A. Shareholders are not liable to pay calls on their shares

o B. No liability companies are typically involved in mining

exploration

o C. A no liability company may also offer shareholders an option to

sell shares back to the company if the company exploration is not
successful

o D. Shareholders can forfeit their shares if they do not pay calls

37.Financing for high-risk companies is often in the form of:

o A. secured loans

o B. no-liability shares
 o C. government grants

o D. corporate bonds

38.Which of the following requirements does NOT apply to a company

seeking a public listing on the Australian Securities Exchange (ASX)?

o A. The company must meet minimum financial requirements

o B. The company must comply with ASX listing rules

o C. The company must issue a prospectus that is to be lodged with

the ASX

o D. The company must have a minimum number of shareholders

39.Which of the following requirements does NOT apply to a company

seeking a public listing on the ASX?

o A. The company must meet minimum financial requirements

o B. The company must comply with ASX listing rules

o C. The company must lodge a prospectus with the ASX on an

annual basis

o D. The company must have a minimum number of shareholders

40.Most companies raise funds by selling their securities in a:

o A. public float

o B. private placement

o C. rights issue

o D. share buyback

41.A company may seek to raise further funds by issuing additional ordinary
shares. The terms and conditions of the new share issue are determined by
the board of directors in consultation with its financial advisers and
 others, and having regard to the preferences of existing shareholders and
the needs of the company. Which of the following is LEAST likely to be a
determinant of the price that is eventually struck?

o A. The discount to current market price that can be offered to

shareholders

o B. The company’s current financial performance

o C. Market conditions at the time of the issue

o D. The company’s future growth prospects

42.Some of the main principles that form the basis of a stock exchange’s
listing rules are:

o A. Companies must disclose all financial information to the public

o B. Companies must ensure fair trading practices

o C. Companies must protect investor interests

o D. Security holders must be consulted on matters of significance

except for agreements between the entity and related parties

43.A rights offering is the issue of:

o A. new shares to the public

o B. bonds to existing shareholders

o C. an option to purchase shares directly to the shareholders

o D. shares to institutional investors

44.A company may raise additional equity capital through:

o A. a rights issue

o B. a placement

o C. a dividend reinvestment scheme

 o D. all of the given answers

45.A right that can only be exercised by the shareholder and not sold is called
a:

o A. renounceable right

o B. transferable right

o C. non-renounceable right

o D. non-transferable right

46.Before making a rights issue, a company’s management must consider

several important variables. Which of the following is NOT one of these
variables?

o A. The effect on the firm’s share price

o B. The effect on the firm’s profits

o C. The effect on the firm’s capital structure

o D. The effect on the firm’s existing shareholders

47.The subscription price in a rights offering is generally:

o A. below the current share price

o B. above the current share price

o C. equal to the current share price

o D. unrelated to the current share price

48.Which of the following is generally NOT a characteristic of rights?

o A. No expiration date

o B. Transferable

o C. Exercisable at a specific price

 o D. Issued to existing shareholders

49.A pro-rata share rights offer means that the offer:

o A. must be made to new investors

o B. must be made to institutional investors

o C. must be made to shareholders on the basis of the number of

shares already held

o D. must be made to the public

50.A pro-rata share rights offer of 1:5 gives existing shareholders:

o A. the right to purchase five new shares for every one share held

o B. the right to purchase one new share for every five shares held

o C. the right to purchase one new share for every ten shares held

o D. the right to purchase ten new shares for every one share held

51.For a share placement, the Australian authority ASIC requires:

o A. a prospectus to be sent to all participating institutions

o B. a financial statement to be sent to all participating institutions

o C. a memorandum of information to be sent to all participating

institutions

o D. a shareholder agreement to be sent to all participating

institutions

52.For a share placement, the Australian authority ASIC or ASX listing rules
require:

o A. The discount from market price must not be above 10 per cent

o B. The discount from market price must not be above 25 per cent

o C. The discount from market price must not be above 50 per cent
 o D. The discount from market price must not be above 75 per cent

53.For a share placement, the ASX listing rules require:

o A. that a company must issue a prospectus for every placement

o B. that a company must notify the ASX within 24 hours of a

placement

o C. that a company that proposes a placement that will bring its total
placements in any 12 month period to more than 15% of the
company’s issued shares may do so only if shareholders ratify
previous placements at the annual general meeting

o D. that a company must seek approval from the ASX for every
placement

54.Share placements may, subject to compliance with certain regulations, be

made to institutional investors. Which of the following conditions is NOT
a requirement of the Australian authority ASIC for share placements?

o A. The placement must be made to institutional investors only

o B. The placement must comply with ASX listing rules

o C. Under no circumstances should placements be in excess of 10%

of the issued shares permitted

o D. There is no need to register a prospectus, but a memorandum of

information detailing the company’s activities should be sent to all
participants

55.If a company raises equity funds by issuing shares to a selected number of

institutional investors, this is known as:

o A. a rights issue

o B. a placement
 o C. a public float

o D. a share buyback

56.Compared with a pro-rata issue of shares, placements usually:

o A. take longer to complete

o B. can be carried out much more quickly

o C. require more regulatory approval

o D. involve more shareholders

57.The main advantage of placements to raise additional equity funds

compared to a rights issue is:

o A. it increases the proportion of ownership by existing shareholders

o B. it is less costly

o C. it is more transparent

o D. it reduces the proportion of ownership by existing shareholders

58.When a takeover company issues additional shares to fund the acquisition

of the shares in a target company this is called:

o A. a debt-funded takeover

o B. an equity-funded takeover

o C. a leveraged buyout

o D. a hostile takeover

59.Which of the following does NOT apply to a dividend reinvestment plan?

o A. Shareholders can choose to reinvest their dividends in additional

shares

o B. Shareholders may receive a discount on the share price

 o C. Companies have encouraged shareholders to use dividend
reinvestment plans

o D. Dividends are paid in the form of additional shares rather than

cash

60.Which of the following is NOT a feature of a dividend reinvestment

scheme for a company?

o A. It allows shareholders to reinvest dividends in additional shares

o B. It can provide a source of equity funding for the company

o C. It may offer shares at a discount to the market price

o D. The shareholders can redeem shares for dividends

61.A dividend reinvestment plan generally ____ on the security.

o A. decreases the return

o B. increases the return

o C. has no effect on the return

o D. stabilizes the return

62.Dividend reinvestment schemes are a significant source of equity for

many Australian companies. Which of the following advantages of
dividend reinvestment schemes may, at times, also be regarded as a
disadvantage?

o A. They provide a steady source of funding

o B. They increase shareholder ownership

o C. Such schemes allow dividends to be paid while retaining cash

for future growth

o D. They reduce the need for external financing

63.____ are promised a fixed periodic dividend, the payment of which must
be paid before that of ordinary shares.

o A. Common shareholders

o B. Preferred shareholders

o C. Bondholders

o D. Debenture holders

64.Any unpaid dividends that must be paid before payment of dividends to

ordinary shareholders are called ____ preference shares.

o A. non-cumulative

o B. cumulative

o C. participating

o D. convertible

65.A company is likely to issue ____ if it has reached its optimal gearing
level.

o A. ordinary shares

o B. bonds

o C. debentures

o D. preference shares

66.Holders of ____ preference shares are entitled to dividend payments

beyond the stated dividend rate.

o A. participating

o B. non-participating

o C. cumulative

o D. non-cumulative
67.A preference share issue offers all of the following advantages to a
company except:

o A. a fixed dividend payment

o B. no voting rights for shareholders

o C. a higher claim on assets than ordinary shares

o D. an indefinite maturity

68.Which of the following is NOT a feature of preference shares?

o A. Fixed dividend payments

o B. Higher claim on assets than ordinary shares

o C. No voting rights

o D. An important source of company funding

69.Preference shares:

o A. have their dividend fixed at the issue date

o B. have their dividend variable based on company performance

o C. have voting rights

o D. are always convertible into ordinary shares

70.Preference shares have a number of features similar to debt that

distinguish them from ordinary shares. Which of the following features
may be incorporated in a preference share issue?

o A. Cumulative or non-cumulative

o B. Convertible or non-convertible

o C. Redeemable or non-redeemable

o D. All of the given answers

71.Convertible preference shares are normally converted into:

o A. bonds

o B. debentures

o C. shares

o D. cash

72.Compared with ordinary shares, preference shares usually:

o A. have voting rights

o B. have dividends set at issue

o C. have variable dividends

o D. have a lower claim on assets

73.A convertible note is a/an:

o A. equity instrument that the holder has the option to convert into
bonds

o B. equity instrument that the holder has the option to convert into
shares

o C. debt instrument that the holder has the option to convert into an
initially specified number of shares

o D. debt instrument that the holder has the option to convert into
cash

74.Which of the following statements is NOT a feature of convertible notes?

o A. They can be converted into shares

o B. They pay interest until conversion

o C. Maturity of convertible notes is usually shorter than straight debt

instruments
 o D. They provide a fixed income until conversion

75.Which of the following is NOT a feature of convertible notes?

o A. They can be converted into shares

o B. They pay interest until conversion

o C. Convertible notes offer a higher interest rate than straight debt

instruments

o D. They provide a fixed income until conversion

75.Which of the following is NOT a feature of convertible notes?

o A. They can be converted into shares

o B. They pay interest until conversion

o C. Convertible notes offer a higher interest rate than straight debt

instruments

o D. They provide a fixed income until conversion

76.An advantage of a convertible security for a company is that it can

generally be sold with interest rates ____ other non-convertible debt
securities.

o A. higher than

o B. equal to

o C. lower than

o D. unrelated to

77.The buyer of a convertible security accepts a lower rate of interest

because of:

o A. the lower risk associated with the security

o B. the higher liquidity of the security

 o C. the tax benefits associated with the security

o D. the possibility of becoming a shareholder in the future

78.When a convertible security is issued, the issue price is usually ____ the
current market price of the company’s share.

o A. above

o B. close to

o C. below

o D. unrelated to

79.Which of the following is NOT an advantage for a company that issues a

convertible note?

o A. Lower borrowing costs

o B. Deferred dilution of equity

o C. Potential to convert debt to equity

o D. There is an increase in financial leverage upon conversion

80.A company is advised to issue convertible notes. They are advised of the
conditions applicable to the convertible note issue. Which of the
following conditions is incorrect?

o A. The holder of the note has the right to convert the note into
preference shares

o B. The holder of the note has the right to convert the note into
ordinary shares

o C. The note pays interest until conversion

o D. The note has a fixed maturity date

81.Compared with straight debt, convertible notes may offer a company:

 o A. lower borrowing costs

o B. higher borrowing costs

o C. the same borrowing costs

o D. variable borrowing costs

82.When a company wants to increase the marketability of a rights issue, it

may offer:

o A. bonds attached

o B. options attached

o C. warrants attached

o D. shares attached

83.When warrants are converted by a holder:

o A. the number of shares decreases

o B. the number of shares remains the same

o C. only the number of shares increases

o D. the number of shares and the share price increase

84.Which of the following is NOT an advantage for a company that sells a

company-issued option with a rights issue?

o A. It can make the rights issue more attractive

o B. It can provide additional future funding

o C. It can increase shareholder participation

o D. There is no certainty that the future funds from the exercise of

the option will eventuate

85.Which of the following about equity warrants is NOT correct?

 o A. Warrants give the holder the right to purchase shares at a
predetermined price

o B. Warrants are often issued with bonds or preferred stock

o C. Warrants can be traded separately from the bonds or stock they

are issued with

o D. Dividends for warrants are usually lower than for ordinary

shares

86.Which of the following about equity warrants is NOT correct?

o A. Warrants give the holder the right to purchase shares at a

predetermined price

o B. Warrants are often issued with bonds or preferred stock

o C. Warrants can be traded separately from the bonds or stock they

are issued with

o D. A warrant holder receives a dividend, unlike a rights holder

87.Which financial instrument gives the holder an option to purchase a

specified number of shares at a predetermined price over a given period?

o A. An equity warrant

o B. A bond

o C. A convertible note

o D. A preference share

88.Which one of the following conditions for an equity warrant that is

generally attached to a bond issue is NOT correct?

o A. A warrant holder can purchase shares at a predetermined price

o B. A warrant holder receives dividend payments over the life of the

warrant
 o C. A warrant holder can trade the warrant separately from the bond

o D. A warrant holder can exercise the warrant at any time before

expiration

89.Which of the following statements about company-issued equity warrants

is incorrect?

o A. They give the holder the right to purchase shares at a

predetermined price

o B. They are often issued with bonds or preferred stock

o C. Because company-issued equity warrants are attached to a bond

they have no value

o D. They can be traded separately from the bonds or stock they are
issued with

90.Which of the following is NOT a similarity between a right and a

warrant?

o A. Both give the holder the right to purchase shares at a

predetermined price

o B. Both can be traded separately from the shares they are issued
with

o C. Both can be exercised at any time before expiration

o D. A right and a warrant both have similar maturities

91.The internal relationship between shareholders, the board of directors and

the managers of a company is called:

o A. corporate finance

o B. corporate governance

o C. corporate structure
 o D. corporate strategy

True / False Questions

92.A principal objective of a business organisation is the
maximisation of its profits. TRUE/FALSE
93.The investment decision for a corporation involves the types of
securities it is going to issue or invest in. TRUE/FALSE

94.If the calculated IRR on an investment proposal is greater than the

required rate of return, the company should proceed with the project.
TRUE/FALSE
95.Business risk is determined in part by a corporation's choice of
business activity and the manner in which it has financed those
activities. TRUE/FALSE
96.A low debt-to-equity ratio for a company means that a rise in interest
rates will not affect the variable rate debt issued by the company.
TRUE/FALSE

97.Financial risk refers to risks arising from the different types of debt
securities issued by a company. TRUE/FALSE

98.A company's debt-to-equity ratio is determined in practice with

reference to four main criteria and not by finance theory.
TRUE/FALSE

99.In consultation with a company, the promoter (an investment bank)

will seek flotation of the company shares. TRUE/FALSE

100. Limited liability shares are generally sold to investors on

a fully paid basis. TRUE/FALSE

101. A pro-rata offer of rights to existing shareholders must be

accompanied by a prospectus. TRUE/FALSE