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Banking
Q:
When you deposit $50 in the First National Bank,
A) its liabilities decrease by $50.
B) its assets increase by $50.
C) its reserves decrease by $50.
D) only B and C of the above occur.
Q:
The adjusted present value approach takes into account the effects of leverage on risk as debt is repaid. True or False
Q:
When you deposit $50 in the First National Bank,
A) its liabilities decrease by $50.
B) its assets increase by $50.
C) its reserves increase by $50.
D) only B and C of the above occur.
Q:
The primary advantage of the cost of capital method is its relative computational simplicity. True or False
Q:
In general, banks make profits by selling ________ liabilities and buying ________ assets.
A) long-term; shorter-term
B) short-term; longer-term
C) illiquid; liquid
D) risky; risk-free
Q:
The adjusted present value method implies that the firm should optimally use 100% debt financing to take maximum advantage of the tax shield created by the tax deductibility of interest. True or False
Q:
Banks earn profits by selling ________ with attractive combinations of liquidity, risk, and return, and using the proceeds to buy ________ with a different set of characteristics.
A) loans; deposits
B) securities; deposits
C) liabilities; assets
D) assets; liabilities
Q:
Without adjusting for the cost of financial distress, the adjusted present value method implies that the value of the firm could be increased by continuously taking on more debt. True or False
Q:
A bank's largest source of funds is its
A) nontransaction deposits.
B) checking deposits.
C) borrowing from the Fed.
D) federal funds.
Q:
Although the proposition that the value of the firm should be independent of the way in which it is financed may make sense for a firm whose debt-to-capital ratio is relatively stable and similar to the industry's, it is highly problematic when it is applied to highly leveraged transactions. True or False
Q:
Loans
A) are the largest category of bank assets.
B) provide most of the bank's revenues.
C) earn the highest return of all bank assets.
D) do all of the above.
E) are only A and B of the above.
Q:
Which of the following bank assets are the most liquid?
A) consumer loans
B) reserves
C) cash items in process of collection
D) U.S. government securities
Q:
To determine the total value of the firm using the adjusted present value method, add the present value of the firm's cash flows to equity, interest tax savings, and terminal value discounted at the firm's unlevered cost of equity and subtract the present value of the expected cost of financial distress. True or False
Q:
Which of the following bank assets are the least liquid?
A) reserves
B) mortgage loans
C) cash items in process of collection
D) deposits with other banks
Q:
In discount projected tax savings in the adjusted present value method, the firm's unlevered cost of equity should be used, since it reflects a higher level of risk than either the WACC or after-tax cost of debt. Tax savings are subject to risk comparable to the firm's cash flows in that a highly leveraged firm may default and the tax savings go unused. True or False
Q:
The present value of tax savings is irrelevant to the adjusted present value method. True or False
Q:
The most important category of assets on a bank's balance sheet is
A) discount loans.
B) securities.
C) loans.
D) cash items in the process of collection.
Q:
Secondary reserves ________
A) can be converted into cash with low transaction costs.
B) are not easily converted into cash and are, therefore, of secondary importance to banks.
C) count toward meeting required reserves, but only at a rate of $0.50 per dollar of secondary reserves.
D) none of the above.
Q:
In the adjusted present value method, the levered cost of equity is used for discounting cash flows during the period in which the capital structure is changing and the weighted-average cost of capital for discounting during the terminal period. True or False
Q:
Many analysts use the cost of capital method because of its relative simplicity. True or False
Q:
Because of their ________ liquidity, ________ U.S. government securities are called secondary reserves.
A) low; short-term
B) low; long-term
C) high; short-term
D) high; long-term
Q:
The expected cost of and probability of occurring of financial distress are easily forecasted. True or False
Q:
Which of the following are not reported as assets on a bank's balance sheet?
A) Cash items in the process of collection
B) Borrowings
C) U.S. Treasury securities
D) Reserves
Q:
In applying the adjusted present value method, the present value of a highly leveraged transaction should reflect the present value of the firm without leverage plus the present value of tax savings plus the present value of expected financial distress. True or False
Q:
Which of the following are not reported as assets on a bank's balance sheet?
A) cash items in the process of collection
B) deposits with other banks
C) U.S. Treasury securities
D) checkable deposits
Q:
Financial distress does not have a material indirect cost to firms able to avoid bankruptcy or liquidation. True or False
Q:
Which of the following are reported as assets on a bank's balance sheet?
A) borrowings
B) reserves
C) savings deposits
D) bank capital
E) only A and B of the above
Q:
The direct cost of financial distress includes the costs associated with reorganization in bankruptcy and ultimately liquidation. True or False
Q:
Which of the following are reported as assets on a bank's balance sheet?
A) cash items in the process of collection
B) deposits with other banks
C) checkable deposits
D) bank capital
E) only A and B of the above
Q:
Which of the following are reported as assets on a bank's balance sheet?
A) discount loans from the Fed
B) loans
C) borrowings
D) only A and B of the above
Q:
In using the adjusted present value method to value highly leveraged transactions, the analyst need not be concerned about the costs of financial distress. True or False
Q:
Increased borrowing by a firm will, other things equal, increase its tax liability. True or False
Q:
Which of the following would substitute for discount loans?
A) loans to businesses
B) repurchase agreements
C) investing in Eurodollars
D) loans to bank holding companies
E) reverse repurchase agreements
Q:
The tax benefits of higher leverage may be partially or entirely offset by the higher probability of default associated with an increase in leverage. True or False
Q:
Bank loans from the Federal Reserve are called ________ and represent a ________ of funds.
A) discount loans; use
B) discount loans; source
C) fed funds; use
D) fed funds; source
Q:
In the presence of taxes, firms are often less leveraged than they should be, given the potentially large tax benefits associated with debt. Firms can increase market value by increasing leverage to the point at which the additional contribution of the tax shield to the firm's market value begins to decline. True or False
Q:
Large-denomination CDs are ________, so that like a bond they can be resold in a ________ market before they mature.
A) nonnegotiable; secondary
B) nonnegotiable; primary
C) negotiable; secondary
D) negotiable; primary
Q:
The justification for the adjusted present value (APV) method reflects the theoretical notion that firm value should not be affected by the way in which it is financed. However, recent studies empirical suggest that for LBOs, the availability and cost of financing does indeed impact financing and investment decisions. True or False
Q:
Which of the following are checkable deposits?
A) savings accounts
B) small-denomination time deposits
C) negotiable order of withdrawal accounts
D) certificates of deposit
Q:
The justification for the adjusted present value method reflects the theoretical notion that firm value should is affected by the way in which it is financed. True or False
Q:
Which of the following are not checkable deposits?
A) savings accounts
B) small-denomination time deposits
C) negotiable order of withdrawal accounts
D) all of the above
E) only A and B of the above
Q:
The unlevered cost of equity is often viewed as the appropriate discount rate rather than the cost of debt or a risk-free rate because tax savings are subject to risk, since the firm may default on its debt or be unable to utilize the tax savings due to continuing operating losses. True or False
Q:
Which of the following is checkable deposits?
A) savings accounts
B) Small-denomination time deposits
C) Money market deposit accounts
D) Certificates of deposit
Q:
The total value of the firm according to the adjusted present value method is the present value of the firm's free cash flows to equity investors plus the present value of future tax savings discounted at the firm's unlevered cost of equity. True or False
Q:
Because passbook savings are ________ liquid for the depositor than checking accounts, they earn ________ interest rates.
A) less; higher
B) less; lower
C) more; higher
D) more; lower
Q:
Using the adjusted present value method to value a LBA assumes the total value of the firm is the present value of the firm's free cash flows to lenders plus the present value of future tax savings discounted at the firm's unlevered cost of equity. True or False
Q:
Because checking accounts are ________ liquid for the depositor than passbook savings, they earn ________ interest rates.
A) less; higher
B) less; lower
C) more; higher
D) more; lower
Q:
Some analysts suggest that the problem of a variable discount rate can be avoided by separating the value of a firm's operations into two components: the firm's value as if it were debt free and the value of interest tax savings. True or False
Q:
Which of the following statements is false?
A) Checkable deposits are usually the lowest-cost source of bank funds.
B) Checkable deposits are the primary source of bank funds.
C) Checkable deposits are payable on demand.
D) Checkable deposits include NOW accounts.
Q:
The deal makes sense to lenders and noncommon equity investors if the present value of free cash flow to equity investors exceeds the total cost of the deal. True or False
Q:
Checkable deposits and money market deposit accounts are
A) payable on demand.
B) liabilities of the banks.
C) assets of the banks.
D) only A and B of the above.
E) only A and C of the above.
Q:
An LBO deal makes sense to common equity investors if the present value of free cash flow to equity exceeds the value of the equity investment in the deal. True or False
Q:
The share of checkable deposits in total bank liabilities has
A) expanded moderately over time.
B) expanded dramatically over time.
C) shrunk over time.
D) remained virtually unchanged since 1960.
Q:
Because the firm's cost of equity changes over time, the firm's cumulative cost of equity is used to discount projected cash flows. This reflects the fact that each period's cash flows generate a different rate of return. True or False
Q:
Which of the following are reported as liabilities on a bank's balance sheet?
A) discount loans
B) cash items in the process of collection
C) state government securities
D) all of the above
E) only B and C of the above
Q:
Using the cost of capital method to value LBOs requires adjusting the firms unlevered beta in each period using the firm's projected debt-to-equity ratio for that period. True or False
Q:
Which of the following are reported as liabilities on a bank's balance sheet?
A) reserves
B) checkable deposits
C) loans
D) deposits with other banks
Q:
As the LBO's extremely high debt level is reduced, the cost of equity needs to be adjusted to reflect the decline in risk, as measured by the firm's unlevered beta. True or False
Q:
A bank's balance sheet
A) shows that total assets equal total liabilities plus equity capital.
B) lists sources and uses of bank funds.
C) indicates whether or not the bank is profitable.
D) does all of the above.
E) does only A and B of the above.
Q:
For simplicity, the market value of common equity can be assumed to grow in line with the projected growth in a firms account receivables. True or False
Q:
Which of the following statements is false?
A) A bank's assets are its uses of funds.
B) A bank issues liabilities to acquire funds.
C) A bank's assets provide the bank with income.
D) Bank capital is an asset on the bank balance sheet.
Q:
Projecting future annual debt-to-equity ratios depends on knowing the firms debt repayment schedules and projecting growth in the market value of shareholders' equity. True or False
Q:
Which of the following statements is true?
A) A bank's assets are its uses of funds.
B) A bank's assets are its sources of funds.
C) A bank's liabilities are its uses of funds.
D) Only B and C of the above are true.
Q:
Since an LBOs debt is to be paid off over time, the cost of equity decreases over time, assuming other factors remain unchanged. Therefore, in valuing a leveraged buyout, the analyst must project free cash flows, adjusting the discount rate to reflect changes in the capital structure. True or False
Q:
Which of the following statements is true?
A) A bank's assets are its sources of funds.
B) A bank's liabilities are its uses of funds.
C) A bank's balance sheet shows that total assets equal total liabilities plus equity capital.
D) All of the above are true.
Q:
The extremely high leverage associated with leveraged buyouts significantly increases the riskiness of the cash flows available to equity investors as a result of the increase in fixed interest and principal repayments that must be made to lenders. Consequently, the cost of equity should be adjusted for the increased leverage of the firm. True or False
Q:
A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal ________ in its international reserves and the monetary base.
A) sale; purchase; increase
B) sale; sale; decline
C) purchase; sale; increase
D) purchase; purchase; decline
Q:
Many firms reduce their outstanding debt relative to equity and such changes in the capital structure distort valuation estimates based on traditional DCF methods. True or False
Q:
A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal ________ in its international reserves and the monetary base.
A) sale; purchase; decline
B) sale; sale; increase
C) purchase; sale; increase
D) purchase; sale; decline
Q:
If the debt-to-equity ratio is expected to fluctuate substantially during the forecast period, applying conventional capital budgeting techniques that discount future cash flows with a constant weighted average cost of capital (CC) is appropriate. True or False
Q:
A central bank sale of ________ to purchase ________ in the foreign exchange market results in an equal decline in its international reserves and the monetary base.
A) foreign assets; domestic currency
B) foreign assets; foreign currency
C) domestic currency; foreign assets
D) domestic currency; domestic currency
Q:
The adjusted present value method values firm without debt and then subtracts the value of future tax savings resulting from the tax-deductibility of interest. True or False
Q:
The cost of capital method attempts to adjust future cash flows for changes in the cost of capital as the firm reduces its outstanding debt. True or False
Q:
A central bank sale of ________ to purchase ________ in the foreign exchange market results in an equal rise in its international reserves and the monetary base.
A) foreign assets; domestic currency
B) foreign assets; foreign currency
C) domestic currency; foreign assets
D) domestic currency; domestic currency
Q:
By the end of 2010, China had accumulated more than $2 trillion of international reserves. How did China accomplish this? Is the policy sustainable?
Q:
Once the LBO has been consummated, the firm's perceived ability to meet its obligations to current debt and preferred stockholders often deteriorates because the firm takes on a substantial amount of new debt. The firm's pre-LBO debt and preferred stock may be revalued in the market by investors to reflect this higher perceived risk, resulting in a significant reduction in the market value of both debt and preferred equity owned by pre-LBO investors. True or False
Q:
Describe the pros and cons for controls on capital inflows and outflows.
Q:
It is impossible for a leveraged buyout to make sense to common equity investors but not to other investors, such as pre-LBO debt holders and preferred stockholders. True or False
Q:
What are the arguments for and against the IMF acting as an international lender of last resort?
Q:
Explain graphically the speculative attacks that occurred against the British pound in 1992, the Mexican peso in 1994, the Thai baht in 1997, the Brazilian real in 1999, and the Argentine peso in 2002.