CA51021: Financial Markets

Compilation of Quizzes

QUIZ 1: Financial Markets and Institutions, and Determinants of

Interest Rates 2
THEORIES 2
APPLICATION 9
QUIZ 2: Monetary Policy, Money Markets, and Mortgage 12
THEORIES 12
APPLICATION 17
PRELIMS 20
THEORIES 20
APPLICATION 24
QUIZ 3 - with solutions 30
THEORIES 30
APPLICATION 34
QUIZ 4: Derivatives and Forex - with solutions 42
THEORIES 42
APPLICATION 44
 CA51021: Financial Markets
QUIZ 1: Financial Markets and Institutions, and Determinants of
Interest Rates

THEORIES
1. If the Treasury yield curve is upward sloping, how should the yield to maturity on
a 10-year Treasury coupon bond compare to that on a 1-year T-bill?
a. It is impossible to tell without knowing the coupon rates of the bonds.
b. b. The yield on a 10-year bond would be less than that on a 1-year bill.
c. The yield on a 10-year bond would have to be higher than that on a 1year
bill because of the maturity risk premium.
d. It is impossible to tell without knowing the relative risks of the two securities.
e. The yields on the two securities would be equal.

2. If savers decide to save more, ceteris paribus, the loanable funds theory predicts:
a. A reduction in investment and interest rates
b. A reduction in interest rates and more investment
c. An increase in investment and interest rates
d. Higher economic growth
e. A fall in the exchange rate

3. Statement 1. If your father in New York sold 100 shares of Tesla through his
broker to an investor in Los Angeles, this would be a primary market transaction.
Statement 2. While the two somehow perform similar functions, investment banks
generally specialize in taking deposits and lending money, whereas commercial
banks generally aid companies raise large amounts of capital from investors.
a. Statement 1 is true
b. Statement 2 is true
c. Both statements are true
d. Both statements are false

4. Which of the following factors would be most likely to lead to an increase in

nominal interest rates?
a. The economy falls into depression.
b. A new technology like blockchain has just been introduced, and it
increases investment opportunities.
c. There is a reduction in expected inflation.
d. The Federal Reserve decides to try to stimulate the economy.
e. Households decreased their consumption and increase their savings.

5. Trading is carried out on the floor of the New York Stock Exchange by
a. he negotiation process.
b. investment bankers.
 c. the auction process.
d. a telecommunications network.

6. If the current corporate bond yield curve is upward sloping. Under this situation,
then we could be sure that
a. Long-term bonds are a better buy than short-term bonds.
b. Inflation is expected to decline in the future.
c. The economy is not in a recession.
d. Long-term interest rates are more volatile than short-term rates.
e. Maturity risk premiums could help to explain the yield curve’s upward
slope.

7. Financial markets have the basic function of

a. bringing together people with funds to lend and people who want to borrow
funds
b. assuring that governments need never resort to printing money.
c. assuring that the swings in the business cycle are less pronounced.
d. Two of the choices above are basic functions of the financial markets

8. Which of the following statements is most correct?

a. Weak-form market efficiency implies that recent trends in stock prices
would be of no use in selecting stocks.
b. All of the statements above are correct.
c. None of the statements above is correct.
d. Market efficiency implies that all stocks should have the same expected return.
e. Semi-strong-form market efficiency implies that all private and public information
is rapidly incorporated into stock prices.

9. Statement 1. The Over-the-Counter (OTC) exchange is not an organization but an

intangible market for trading securities which are not listed by the organized
exchanges.
Statement 2. Unlike the OTC, the stock exchange makes a market in both
outstanding securities and new public issues, making it both a secondary and a
primary market.
a. Statement 1 is True
b. Statement 2 is True
c. Both statements are true
d. Both statements are false

10. According to the loanable funds theory, a fall in interest rates results in:
a. Lower quantity demand for funds.
b. Higher quantity demand for funds.
c. The equilibrium demand for funds.
d. Zero quantity demand for funds.
11. Statement 1. One of the 4 most fundamental factors that affect the cost of money
as discussed in the text is the expected rate of inflation. If inflation is expected to
be relatively high, then interest rates will tend to be relatively low, other things
held constant.
Statement 2. One of the 4f most fundamental factors that affect the cost of money
as discussed in the text is the risk inherent in a given security. The higher the
risk, the higher the security's required return, other things held constant.
a. Statement 1 is True
b. Statement 2 is True
c. Both statements are true
d. Both statements are false

12. When the interest rate is lower than the equilibrium rate of borrowing loanable
funds, then the financial system has:
a. Deficit of funds
b. Short-term funds
c. Surplus of funds
d. Long-term funds

13. Statement 1. Capital market instruments include both long-term debt and common
stocks.
Statement 2. Home mortgage loans are traded in the money market.
a. Statement 1 is True
b. Statement 2 is True
c. Both statements are true
d. Both statements are false

14. Statement 1. A financial intermediary is a corporation that takes funds from

investors and then provides those funds to those who need capital.
Statement 2. A bank that takes in demand deposits and then uses that money to
make long-term mortgage loans is one example of a financial intermediary.
a. Statement 1 is True
b. Statement 2 is True
c. Both statements are true
d. Both statements are false

15. Shares or stocks that are sold to investors without the need to pass through
financial institutions are classified as
a. Global transfer
b. Indirect transfer - Investment bank
c. Direct transfer
d. Indirect transfer - Financial Intermediary
16. An efficient market hypothesis states all public and private information which is
reflected in current market prices is classified as:
a. Semi strong form efficiency
b. Strong form efficiency
c. Weak form efficiency
d. Market efficiency

17. Assume that interest rates on 20-year Treasury and corporate bonds are as
follows:

T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%

The differences in these rates were probably caused primarily by:

a. Default and liquidity risk differences.
b. Maturity risk differences.
c. Tax effects.
d. Real risk-free rate differences.
e. Inflation differences.

18. It describes new tech that seeks to improve and automate the delivery and use of
financial services. ?3??3??3?
a. Enterprise Resource Planning
b. Financial inclusion
c. Wire transfer.
d. Economic order quantity.
e. Financial Technology
f. Online banking.

19. You recently sold 100 stocks of Apple to your sister at a family reunion. At the
reunion your sister gave you a check for the stock and you gave your brother the
stock certificates. Which of the following best describes this transaction?
a. This is an example of a primary market transaction.
b. This is an example of an exchange of physical assets.
c. This is an example of a direct transfer of capital.
d. This is an example of a money market transaction.
e. This is an example of a derivative market transaction.

20. Financial derivatives include

a. stocks.
b. b. bonds.
c. futures.
d. none of the above.
e. pension.
f. insurance.
21. Statement 1. The risk that interest rates will increase, and that increase will lead to
a decline in the prices of outstanding bonds, is called “interest rate risk,” or “price
risk.”
Statement 2. The longer the maturity of a Treasury (or any other) security, the
smaller the interest rate risk.
a. Statement 1 is True
b. Statement 2 is True
c. Both statements are true
d. Both statements are false

22. Statement 1. Hedge funds are similar to mutual funds in some respects.
Statement 2. The primary differences are that hedge funds are more highly
regulated, have less flexibility regarding what they can buy.
a. Statement 1 is True
b. Statement 2 is True
c. Both statements are true
d. Both statements are false

23. Statement 1. The “yield curve” shows the relationship between bonds' maturities
and their yields.
Statement 2. A downward-sloping yield curve indicates generally cheaper short-
term borrowing costs than long-term borrowing costs.
a. Statement 1 is true.
b. Both statements are false.
c. Statement 2 is true.
d. Both statements are true.

24. A _________ is set up so that employees of corporations or governments can

receive income after retirement.
a. savings bank
b. pension fund
c. life insurance company
d. credit union

25. Which of the following statements is false?

a. Trading strategies based on historical market data are known as technical
analysis.
b. If the market is semi-strong-form efficient, a diligent study of financial
statements is useful.
c. A simple example that illustrates the random walk notion is the flipping of a coin.
d. Despite a positive trend in stock prices, price changes may still follow a random
walk.
26. It is the process of offering shares of a private corporation to the public in a new
stock issuance.
a. Private Placement.
b. Primary Market Transaction.
c. Initial Public Offering
d. Seasoned offering.
e. Secondary Market Transaction.
f. Underwriting.

27. Statement 1. If the maturity risk premium (MRP) equals zero, the Treasury bond
yield curve must be flat.
Statement 2. If inflation is expected to increase in the future and the maturity risk
premium (MRP) is greater than zero, the Treasury bond yield curve must be
upward sloping.
a. Statement 2 is true.
b. Both statements are true.
c. Both statements are false.
d. Statement 1 is true.

28. A _________ is a type of financial intermediary that pools savings of individuals

and makes them available to business and government demanders. Funds are
obtained through the sale of shares.
a. savings bank
b. b. credit union
c. c. savings and loans
d. mutual fund

29. Which version of the EMT states that only public information is reflected in
prices?
a. Weak form.
b. semi-strong form.
c. None of the choices
d. Strong form.

30. Statement 1. When a corporation's shares are owned by a few individuals who are
associated with the firm's management, we say that the stock is publicly-owned.
Statement 2. A publicly-owned corporation is a company whose stocks are held
by the investing public, which may include other corporations as well as
institutional investors.
a. Both statements are true.
b. Statement 1 is true.
c. Statement 2 is true.
d. Both statements are false.
31. Securities exchanges create efficient markets that do all of the following EXCEPT
a. control the supply and demand for securities through price.
b. allow the price to be determined by supply and demand of securities.
c. allocate funds to the most productive uses.
d. ensure a market in which the price reflects the true value of the security.

32. Statement 1. In the OTC market, the ask price is the highest price offered by a
dealer to purchase a given security.
Statement 2. In the OTC market, the bid price is the lowest price offered by a
dealer to sell a given security.
a. Statement 2 is true.
b. Both statements are true.
c. Statement 1 is true.
d. Both statements are false.
 APPLICATION
33. Kern Corporation's 4-year bonds yield 7.30% and 4-year T-bonds yield 4.10%. The
real risk-free rate is r* = 2.5%, the default risk premium for Kern's bonds is DRP =
1.90% versus zero for T-bonds, the liquidity premium on Kern's bonds is LP =
1.3%, and the maturity risk premium for all bonds is found with the formula MRP =
(t – 1) × 0.1%, where t = number of years to maturity. What is the inflation
premium (IP) on all 5-year bonds?
a. 1.20%
b. 1.32%
c. 1.60%
d. 1.30%
e. 1.45%
f. 1.22%
g. 1.68%

34. Keys Corporation's 5-year bonds yield 6.50%, and T-bonds with the same maturity
yield 4.40%. The default risk premium for Keys' bonds is DRP = 0.40%, the
liquidity premium on Keys' bonds is LP = 1.70% versus zero on T-bonds, inflation
premium (IP) is 1.6%, and the maturity risk premium (MRP) on 5-year bonds is
0.40%. What is the real risk-free rate, r*?
a. 2.30%
b. 2.40%
c. 2.50%
d. 2.10%
e. 2.20%
f. 2.60%

35. Kailly Inc's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.90%. The real
risk-free rate is r* = 2.5%, the default risk premium for Kelly's bonds is DRP =
0.40%, the liquidity premium on Kailly's bonds is LP = 2.2% versus zero on T-
bonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium
(MRP) on all 5-year bonds?
a. 1.09%
b. 0.99%
c. 0.73%
d. 0.90%
e. 0.81%

36. Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.50%,
a maturity premium of 0.20% per year to maturity applies, i.e., MRP = 0.20%(t),
where t is the years to maturity. Suppose also that a liquidity premium of 0.54%
and a default risk premium of 1.35% applies to A-rated corporate bonds. What is
 the difference in the yields on a 5-year A-rated corporate bond and on a 10-year
Treasury bond? Here we assume that the pure expectations theory is NOT valid.
a. 0.81%
b. 0.83%
c. 0.96%
d. 0.77%
e. 0.94%
f. 0.85%
g. 0.89%

37. 5-year Treasury securities yield 5.5%. The inflation premium (IP) is 1.9%, and the
maturity risk premium (MRP) on 5-year T-bonds is 0.4%. There is no liquidity
premium on these bonds. What is the risk-free rate, r rf for a 5-year investment?
a. 3.87%
b. 3.20%
c. 5.10%
d. 2.88%
e. 3.52%

38. Suppose the real risk-free rate is 3.00%, the average expected future inflation rate
is 2.25%, and a maturity risk premium of 0.10% per year to maturity applies, i.e.,
MRP = 0.10%(t), where t is the years to maturity. What rate of return would you
expect on a 2-year Treasury bond, assuming the pure expectations theory is not
valid?
a. 5.62%
b. 5.45%
c. 5.08%
d. 5.90%
e. 6.19%
f. 5.35%

39. 5-year Treasury bonds yield 5.5%. The inflation premium (IP) is 1.9%, and the
maturity risk premium (MRP) on 5-year T-bonds is 0.5%. There is no liquidity
premium on these bonds. What is the real risk-free rate, r*?
a. 2.88%
b. 3.10%
c. 3.87%
d. 3.20%
e. 3.30%
f. 2.59%
g. 3.52%

40. Suppose 10-year T-bonds have a yield of 5.42% and 10-year corporate bonds yield
6.75%. Also, corporate bonds have a 0.25% liquidity premium versus a zero
 liquidity premium for T-bonds, and the maturity risk premium on both Treasury
and corporate 10-year bonds is 1.15%. What is the default risk premium on
corporate bonds?
a. 1.45%
b. 1.60%
c. 1.20%
d. 1.32%
e. 1.08%

41. The treasury securities in PDS are currently yielding 3.0%. Your broker has given
you the following estimates of current interest premiums:
Inflation premium 1.75%
Liquidity premium 1.45%
Maturity risk premium 1.55%
On the basis of these data, calculate the real risk-free rate of return
1.25

42. Suppose 1-year T-bills currently yield 7.0% and the future inflation rate is
expected to be constant at 3.1% per year. What is the real risk-free rate of return,
r*?
3.90

43. Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.50%,
a maturity premium of 0.02% per year to maturity applies, i.e., MRP = 0.20%(t),
where t is the years to maturity. Suppose also that a liquidity premium of 0.80%
and a default risk premium of 1.35% applies to A-rated corporate bonds. What is
the difference in the yields on a 5-year A-rated corporate bond and on a 10-year
Treasury bond? Here we assume that the pure expectations theory is not valid.
1.15 or 2.05

44. Default risk premium of 1.8%. The average inflation rate for the next 10 years is
1.5%, and the maturity risk premium for a typical 10-year security is 2.25%.
Calculate the yield of the 10-year corporate bond
8.00
 CA51021: Financial Markets
QUIZ 2: Monetary Policy, Money Markets, and Mortgage

THEORIES
1. The securities sold in the money market must have an original maturity of one
year or more.
a. True
b. False

2. The pooling and securitization of mortgages move the banks and mortgage
companies from the "originate and distribute" model to the "originate and hold
model".
a. True
b. False

3. EAR is used when the investment horizon or the maturity on security is less than
a year. This accounts for the compounding of interest for certain money market
securities.
a. True
b. False

4. Pass-through mortgage securities are for primary market investors.

a. True
b. False

5. Risk attributes and returns of collateralized mortgage obligations differ based on

tranches
a. True
b. False

6. The process of mortgage securitization results in the intertwining between

mortgage origination and mortgage financing.
a. True
b. False

7. Everything else equal, an effective annual rate will be greater than the bond
equivalent yield on the same security.
a. True
b. False

8. In the secondary mortgage markets, banks and mortgage companies become

servicers, collecting payments on behalf of the secondary investors after
mortgages have been pooled together or securitized.
 a. True
b. False

9. A P 1,500.00 91-day T-Bill was sold for P 900.00 on Jan 1, 2021. On Apr 2, 2021, it
is redeemed at P 1,500.00. The investor earns the difference between the face
value and the purchase price if he chooses to hold the T-Bill until maturity.
a. True
b. False

10. Fiscal policy is the use of government action to influence a nation's economy.
a. True
b. False

11. A large portion of the mortgage payment goes towards the principal, during the
early life of a mortgage loan.
a. True
b. False

12. Individual investors participate in the money markets through direct and indirect
investments in money market securities via banks or money market mutual funds
a. True
b. False

13. Some money market securities such as treasury bills and commercial papers are
bought at a discount.
a. True
b. False

14. The mortgage market is participated largely by individuals. Therefore, the

information available on these issuers are more extensive and must follow rules
and regulations.
a. True
b. False

15. A ________ placed against mortgaged property ensures that the property cannot
be sold (except by the lender) until the mortgage is paid off
a. collateral
b. lien
c. discount
d. down payment

16. Contractionary monetary policy is described by the following statements EXCEPT:

a. This is the monetary policy employed to help a country out of a recession.
 b. This is used when the central bank wants to slow down the economy and curb
the effects of inflation.
c. Contractionary monetary policy is achieved by increasing discount rates and
decreasing money in circulation.
d. When the BSP enacts the contractionary policy, commercial banks are mandated
to increase reserve ratios.

17. What is the money market security used to finance government expenditures?
a. T-Bills
b. Commercial papers
c. treasury shares
d. stocks

18. It is employed to help a nation out of inflation

a. Expansionary Monetary Policy
b. Contractionary Monetary Policy
c. Fiscal Policy
d. Public policy

19. The discount rate is the rate that

a. banks charge for loans to corporate customers.
b. banks charge to lend foreign exchange to customers.
c. the central bank charges on loans to commercial banks.
d. banks charge securities dealers to finance their inventory

20. The most liquid of the money market securities are

a. commercial paper
b. banker's acceptances
c. T-bills
d. Fed funds

21. The discount yield on a T-bill differs from the T-bill's bond equivalent yield (BEY)
because:
I. the discount yield is the return per dollar of face value and the BEY is a return per
dollar originally invested.
II. a 360-day year is used on the discount yield and the BEY uses 365 days.
III. the discount yield is calculated without compounding, and the BEY is calculated with
compounding.
a. I only
b. II only
c. I and II only
d. II and III only

22. i= [(Pf- P0 )/P0 ] x 365/n is the formula for

 a. bond equivalent yield
b. effective annual return
c. discount yield
d. time value of money

23. A short-term unsecured promissory note issued by a company is

a. commercial paper.
b. a T-bill.
c. a repurchase agreement.
d. a negotiable CD.

24. Which of the following descriptions does not apply to money market securities?
a. Short-term
b. Low-risk
c. Highly liquid
d. Long maturity

25. The schedule showing how monthly mortgage payments are split into principal
and interest is called a(n)
a. securitization schedule.
b. balloon payment schedule.
c. graduated payment schedule.
d. amortization schedule

26. It is the nominal value or peso value of a treasury bill

a. market value
b. face value
c. fund value
d. assessed value

27. The process of packaging and/or selling mortgages that are then used to back
publicly traded debt securities is called:
a. Collateralization.
b. Securitization.
c. market capitalization.
d. stock diversification.

28. These securities have low default risk or the risk of late or non-payment of
principal or interest
a. mortgage backed securities
b. pass-through securities
c. collateralized mortgage obligation
d. money market securities
29. Mortgage markets are studied separately from other financial markets because of
the following reasons EXCEPT:
a. A mortgage is specifically related to real property.
b. There is no set size or denomination for primary mortgages.
c. Primary mortgages involve multiple investors
d. The issuers in the mortgage markets are individuals

30. In a mortgage sale is deemed __________ if the buyer has the to sell back the loan
to its original seller should it go bad.
a. Discord
b. with recourse
c. sans recourse
d. either b or c

31. An MBB differs from a CMO or a pass-through in that:

I. the MBB does not result in the removal of mortgages from the balance sheet.
II. an MBB holder has a prepayment risk.
III. cash flows on an MBB are not directly passed through from mortgages.
a. I, II, and III
b. I and II only
c. II and III only
d. I and III only

32. Which of the following is true about the role of a central bank?
a. The central bank legislates laws.
b. It is an institution that manages the currency and monetary policy of a state
or country.
c. The central bank is the lender of last resort for commercial banks and private
entities.
d. A central bank oversees the commercial banking system and insurance
companies
 APPLICATION
33. Luis just bought a P10,000 treasury bill a 120- day treasury bill that has a discount
yield of 4% today. At what price did he buy it for to the nearest peso?
a. P 4,933. Bonus
b. P 4,937.
c. P 4,838.
d. P 4,627.

34. Mayee owns a 50-day maturity money market security that has a bond equivalent
yield of 3.60%. The EAR of this security is?
a. 3.61 percent.
b. 3.55 percent.
c. 3.87 percent.
d. 3.66 percent

35. AJ has invested in a 3-month 1,000,000 certificate of deposit with an annual

interest rate of 1.5%. How much will he be receiving at maturity in total from this
investment?
a. 3,125.00
b. 1,003,125 Bonus
c. 1,003,650
d. 1,000.000

36. Marco has invested all his 1,000,000 savings in treasury bills. He wants you to
calculate the bond equivalent yield and effective annual return on the treasury
bills he bought at 99.4% of its face value, 35 days maturity.
a. BEY = 6.35%; EAR = 6.50%
b. BEY = 6.29%; EAR = 6.48%
c. BEY = 6.20%; EAR = 6.37%
d. BEY = 6.25%; EAR = 6.42%

37. Tina just moved into her new house in Forbes Park after paying a 30% down
payment of 4,800,000.00. How much is the total price of her new house?
a. 15,000,000
b. 16,000,000
c. 14,000,000
d. 13,000,000

38. Daffodil purchased a P25,500,000 house and paid 20 percent down. She obtains a
fixed-rate mortgage where the annual interest rate is 5.85 percent and there are
360 monthly payments. What is the monthly payment to the nearest peso?
a. P 120,152
b. P 120,348
 c. P 119,445
d. P 136,722

39. Harold is purchasing a commercial paper from RB Corporation for P 494,700.00.

The commercial paper has a face value of P 500,000.00 and is 63 days from
maturity. Calculate the bond equivalent yield on the commercial paper. Express
the answer in the decimal form of up to 4 decimal places where applicable.
0.0621

40. Butz bought a 3-storey townhouse for P 30,000,000.00. Assuming he paid a 30%
down payment at closing, he financed the rest by taking out a 20-year mortgage
with a 5% interest rate from his depository bank and decided he would pay for the
amortization yearly at P 1,685,094.33 a year. Calculate how much interest he will
pay over the life of the loan to the nearest peso.
12,701,887

41. From prev. Number. How much is his loan balance at the end of year 15? Round
off to the nearest peso.
7,295,577

42. From prev. Number. How much of the annual amortization payment is allocated to
the principal at year 7? Round off to the nearest peso.
851,087
43. Paul Justin would like to purchase a treasury bill that is 100 days from maturity for
P9,750. The treasury bill has a face value of P 10,000. How much is the discount
yield? Express the answer in the decimal form of up to 4 decimal places where
applicable.
0.09

44. If Denmark took out a loan for 12,000,000 payable in 20 years at 6% annual interest
to buy a new house after a 25% down payment, how much is his principal balance
at the end of month 4 if he pays 125,000 in monthly amortization? Round off to the
nearest peso.
11,738,043
 CA51021: Financial Markets
PRELIMS

THEORIES
1. Statement 1. Assume that the demand curve for funds increased, yet the supply
curve remained constant, we would expect to see the total amount of funds
supplied and demanded increase and interest rates in general also increase.
Statement 2. When the inflation rate is increasing, interest rates tend to increase,
while interest rates tend to fall when the inflation is decreasing.
a. Statement 1 is true
b. Both Statements are true.
c. Statement 2 is true
d. Both Statements are false.

2. The typical primary mortgage involves

a. three institutions
b. multiple institutions
c. multiple investors
d. a single investor

3. A corporation takes new funds only when its securities are sold
a. in the primary market by a stock exchange broker.
b. in the primary market by an investment bank.
c. in the secondary market by an investment bank.
d. in the secondary market by a commercial bank.

4. Money market securities exhibit which of the following?

I. Large denomination
II. Low default risk
III. Maturity greater than one year
IV. Contractually determined cash flows
a. I, II, III, and IV
b. I, III, and IV
c. II and IV
d. I, II, and III
e. II, III, and IV
f. I, II, and IV

5. Statement 1. Assume that investors expect no inflation; the nominal rate of return
on a very short-term Philippine Treasury bond should be equal to the real risk-free
rate, r*.
 Statement 2. When the investors expect the inflation rate to increase sharply in
the future, then we should not be surprised to see a downward-sloping yield
curve.
a. Both Statements are false.
b. Both Statements are true.
c. Statement 2 is true
d. Statement 1 is true

6. Entities who link buyers and sellers by buying and selling securities at stated
prices are called
a. investment bankers.
b. traders.
c. brokers.
d. dealers.
e. none of the above.

7. Each and every financial market has the following function:

a. It determines the level of interest rates.
b. It allows common stock to be traded.
c. It allows loans to be made.
d. It channels funds from lenders-savers to borrowers-spenders.

8. A lot of studies of market efficiency suggest that the stock market is highly
efficient in the weak form and even reasonably efficient in the semi-strong form.
On the basis of these findings which of the following statements is true?
a. Two of the statements here are correct.
b. The stock price for a company has been increasing for the past 6 months. On the
basis of this information it must be true that the stock price will also increase
during the current month.
c. Information disclosed in companies’ most recent annual reports can be used to
consistently beat the market.
d. Information you read in The Wall Street Journal today cannot be used to
select stocks that will consistently beat the market.
e. All of the statements here are correct.

9. Which of the following is true?

a. Two of the statements here are correct.
b. If the stock market is semi-strong-form efficient, this means that high-beta stocks
should have the same expected return as low-beta stocks.
c. If the stock market is semi-strong-form efficient, this means the expected return
on stocks and bonds should be the same.
d. If the stock market is weak-form efficient this means you cannot use private
information to outperform the market.
e. None of the statements here is correct.
10. Which among the following terms is applied to the process of creation of the
mortgage-backed securities from a pool of mortgages?
a. mortgage bundling
b. mortgage pooling
c. mortgage financing
d. mortgage aggregation
e. mortgage securitization

11. The securities that are sold to savers or investors without transacting through
financial institutions are said to be a(n):
a. Direct transfer
b. Global transfer
c. Indirect transfer through an investment bank
d. Pension transfer
e. Indirect transfer through a financial institution
f. None of the items given is correct

12. Which one of these entities cannot invest in a hedge fund?

a. Pension funds
b. Wealthy investing individuals
c. Small retail investing individuals
d. Insurance Companies

13. Which of the following is found in the capital markets?

a. A U.S. Treasury bond
b. A U.S. Treasury bill
c. A banker’s acceptance
d. A negotiable certificate of deposit

14. A short-term unsecured promissory note issued by large and stable companies
a. a repurchase agreement.
b. a negotiable CD.
c. a T-bill.
d. a banker's acceptance.
e. commercial paper.

15. Statement 1. A private market is one like the Philippine Stock Exchange, where
transactions are handled by members of the organization, while public markets
are those in the black market, where anyone can make transactions.
Statement 2. A common stock is not a derivative, but a futures contract to buy the
stock is a derivative because the value of the futures contract is derived from the
value of the stock.
a. Statement 2 is true
 b. Both Statements are false.
c. Statement 1 is true
d. Both Statements are true.

16. Statement 1. Money markets exist to help reduce the opportunity cost of holding
cash balances.
Statement 2. Because of statement 1, money market securities generally bear low-
risk to appeal to individual investors with excess cash.
a. Both Statements are true.
b. Both Statements are false.
c. Statement 2 is true
d. Statement 1 is true

17. Which among the following is defined as bonds which represent a claim on the
cash flows of an underlying pool of mortgages which flow through to
bondholders?
a. mortgage passthroughs
b. collateralized securities
c. mortgage bonds
d. mortgage collaterals
e. mortgage certificates

18. Statement 1. When a corporation's stocks are owned by a few people who are
associated with the company's management, we say that the stock is closely-held.
Statement 2. The term IPO stands for “initial purchase order,” as when it is the
first time a private party places an order to buy a stock.
a. Both Statements are false.
b. Both Statements are true.
c. Statement 1 is true
d. Statement 2 is true

19. Statement 1. The yield curve depicts the relationship between bonds' maturities
and their corresponding yields.
Statement 2. Due to the fact that the maturity risk premium is normally positive,
the yield curve is normally upward sloping.
a. Statement 2 is true
b. Statement 1 is true
c. Both Statements are false.
d. Both Statements are true.

20. Statement 1. The Primary markets are huge and relevant, while secondary markets
are smaller and less significant.
 Statement 2. The Philippine Stock Exchange is defined as a “primary” market
because it is one of the largest and most important stock markets in the world.

a. Statement 1 is true
b. Both Statements are true.
c. Both Statements are false.
d. Statement 2 is true

APPLICATION
1. Nikolai would like to borrow funds from the bank amounting to P7,000,000 to
purchase his dream vacation house. The bank charges 6% per annum with the
vacation house as collateral. Amortization payments are to be made monthly
amounting to P50,150.17. Of the amortization payment, what is the amount of
interest to be paid at the end of the first month of the loan?
a. P34,772
b. P34,848
c. P34,695
d. P34,924
e. P30,000
f. P35,000
 g. P25,000

2. Nikolai would like to borrow funds from the bank amounting to P7,000,000 to
purchase his dream vacation house. The bank charges 6% per annum with the
vacation house as collateral. Amortization payments are to be made monthly
amounting to P50,150.17. What is the ending balance of the loan principal at year
5?
a. P5,942,972
b. P5,860,616
c. P5,983,538
d. P5,963,306
e. P5,881,359
f. P5,901,999
g. P6,003,670
h. P5,922,537

3. Nikolai would like to borrow funds from the bank amounting to P7,000,000 to
purchase his dream vacation house. The bank charges 6% per annum with the
vacation house as collateral. Amortization payments are to be made monthly
amounting to P50,150.17. For December of the 10 th year, what amount of the
amortization payment goes to Principal?
a. P27,291
b. P27,155
c. P27,841
d. P27,427
e. P27,564
f. P27,702
g. P27,980

4. Nikolai would like to borrow funds from the bank amounting to P7,000,000 to
purchase his dream vacation house. The bank charges 6% per annum with the
vacation house as collateral. Amortization payments are to be made monthly
amounting to P50,150.17. What is the term of the loan?
a. 30 years
b. 20 years
c. 240 years
d. 60 years
e. 15 years
f. 120 years
g. 10 years

5. Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%,
and a maturity risk premium of 0.07% per year to maturity applies to both
corporate and T-bonds, i.e., MRP = 0.07%(t), where t is the years to maturity.
 Suppose also that a liquidity premium of 0.55% and a default risk premium of
0.95% apply to A-rated corporate bonds but not to T-bonds. How much higher
would the rate of return be on a 10-year A-rated corporate bond than on a 5-year
Treasury bond? Here we assume that the pure expectations theory is NOT valid.
Disregard cross-product terms, i.e., if averaging is required, use the arithmetic
average.
a. 1.75%
b. 2.13%
c. 1.65%
d. 2.40%
e. 1.93%
f. 2.03%
g. 1.55%
h. 1.85%

6. Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.50%,
a maturity premium of 0.20% per year to maturity applies, i.e., MRP = 0.20%(t),
where t is the years to maturity. Suppose also that a liquidity premium of 0.30%
and a default risk premium of 1.40% applies to A-rated corporate bonds. What is
the difference in the yields on a 5-year A-rated corporate bond and on a 10-year
Treasury bond? Here we assume that the pure expectations theory is NOT valid,
and disregard any cross-product terms, i.e., if averaging is required, use the
arithmetic average.
a. 0.77%
b. b. 0.89%
c. c. 1.00%
d. d. 0.85%
e. e. 0.94%
f. f. 0.81%
g. g. 0.90%
h. 0.70%

7. Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield
6.75%. Also, corporate bonds have a 0.45% liquidity premium versus a zero
liquidity premium for T-bonds, and the maturity risk premium on both Treasury
and corporate 10-year bonds is 1.15%. What is the default risk premium on
corporate bonds?
a. 1.40%
b. 1.08%
c. 1.00%
d. 1.20%
e. 1.60%
f. 1.45%
g. 0.90%
 h. 1.32%

8. Suppose that P10 million face value commercial paper with a 270-day maturity is
selling for P9.58 million. What is the BEY on the paper?
a. 6.42%
b. 4.50%
c. 6.37%
d. 5.84%
e. 5.93%
f. 4.71%
g. 4.38%
h. 6.28%

9. Quay Corporation's 5-year bonds yield 6.20% and 5-year T-bonds yield 4.40%. The
real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%,
the default risk premium for Quay's bonds is DRP = 1.55% versus zero for T-
bonds, and the maturity risk premium for all bonds is found with the formula MRP
= (t – 1) × 0.1%, where t = number of years to maturity. What is the liquidity
premium (LP) on Quay's bonds?
a. 0.55%
b. 0.20%
c. 0.25%
d. 0.41%
e. 0.36%
f. 0.15%
g. 0.50%
h. 0.45%

10. A 180-day P4.5 million CD has a 4.25 percent annual rate quote. If you buy the CD,
how much is the bond equivalent yield?
a. 4.31%
b. 4.34%
c. 4.19%
d. 4.33%
e. 4.35%

11. A 50-day maturity money market security has a bond equivalent yield of 2.60
percent. The security's EAR is
a. 2.61 percent.
b. 2.67 percent.
c. 2.66 percent.
d. 2.63 percent.
e. 3.66 percent
f. 2.65 percent.
12. Choy Inc.'s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real
risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the
liquidity premium for Choy 's bonds is LP = 0.75% versus zero for T-bonds, and
the maturity risk premium for all bonds is found with the formula MRP = (t – 1) ×
0.1%, where t = number of years to maturity. What is the default risk premium
(DRP) on Choy 's bonds?
a. 6.60%
b. 1.10%
c. 3.50%
d. 7.26%
e. 2.10%
f. 4.70%
g. 1.30%
h. 8.78%

13. The real rate of interest required by investors is 3% p.a., inflation for the next year
is expected to be 4% and the liquidity premium is 1% for every year to maturity. If
the rate quoted on a one-year loan is 12%, the default risk premium must be:
a. 7%
b. 2%
c. 1%
d. 4%
e. 5%
f. 6%
g. 3%

14. A 180-day P4.5 million CD has a 4.25 percent annual rate quote. If you buy the CD,
how much will you collect in 180 days?
a. P4,571,159
b. P4,594,316
c. P4,568,517
d. P4,691,250
e. P4,595,625

15. Anthony intends to borrow money from the bank amounting to P9,000,000 to
purchase a building. The bank charges 7% per annum for the mortgage loan.
Amortization payments are to be made annually for 10 years. For the 10 th year,
what amount of the amortization payment goes to Principal? (nearest peso, no
decimal point, no peso sign, just put the seven digits)
1197568

16. Anthony intends to borrow money from the bank amounting to P9,000,000 to
purchase a building. The bank charges 7% per annum for the mortgage loan.
 Amortization payments are to be made annually for 10 years. What is the
amortization payment? (nearest peso, no decimal point, no peso sign, just put the
seven digits)
1281398

17. Suppose the nominal risk-free rate is 4.20%, the average expected future inflation
rate is 3.10%, and a maturity risk premium of 0.10% per year to maturity applies,
i.e., MRP = 0.10%(t), where t is the years to maturity, hence the pure expectations
theory is NOT valid. What rate of return would you expect on a 4-year Treasury
security? Disregard cross-product terms, i.e., if averaging is required, use the
arithmetic average. (TWO DECIMAL PLACES, AGAIN, 2-decimal places, DO NOT
PUT PERCENT SIGN ANYMORE, Example type 1.40 for 1.40%)
4.60

18. Kath buys a P1 million Treasury bill that is currently selling on a discount basis
(i.e., with no explicit interest payments) at 97.5 percent of its face value. The T-bill
is 120 days from maturity (when the P1 million will be paid). What is the discount
yield? (TWO DECIMAL PLACES, AGAIN, 2-decimal places, DO NOT PUT PERCENT
SIGN ANYMORE, Example type 1.40 for 1.40%)
7.50

19. Kath buys a P1 million Treasury bill that is currently selling on a discount basis
(i.e., with no explicit interest payments) at 97.5 percent of its face value. The T-bill
is 120 days from maturity (when the P1 million will be paid). What is the bond-
equivalent yield? (TWO DECIMAL PLACES, AGAIN, 2-decimal places, DO NOT
PUT PERCENT SIGN ANYMORE, Example type 1.40 for 1.40%)
7.80

20. The real risk-free rate is 3.15%, inflation is expected to be 2.75% this year, and the
maturity risk premium is zero. Ignoring any cross-product terms, what is the
equilibrium rate of return on a 1-year Treasury bond? (TWO DECIMAL PLACES,
AGAIN, 2-decimal places, DO NOT PUT PERCENT SIGN ANYMORE, Example type
1.40 for 1.40%)
5.90
 CA51021: Financial Markets
QUIZ 3

THEORIES
1. Which of the following is NOT included in the calculation of the free cash flow?
a. Capital Expenditure requirements
b. Sales Revenue
c. Operating Income
d. Other Operating income

2. The residual distribution model calculates the amount of dividends that can be
distributed to shareholders before factoring in the capital budget requirement of a
firm.
a. True
b. False

3. This cash disbursement theory leads investors to companies with lower dividend
payout rates because it leads to a higher stock price. What is it?
a. Dividend Irrelevance Theory
b. Bird-In-The-Hand Theory
c. Tax Preference Theory
d. Signaling Hypothesis

4. This theory espouses that a dividend is a sure thing compared to the uncertainty
of a capital gain:
a. Dividend Irrelevance Theory
b. Bird-In-The-Hand Theory
c. Tax Preference Theory
d. Signaling Hypothesis

5. There is a direct relationship between the cost of debt and the cost of equity.

a. True
b. False

6. The firm's target capital structure is consistent with which of the following?
a. Maximum earnings per share (EPS).
b. Minimum cost of debt
c. Minimum risk
d. Minimum weighted ave cost of capital (WACC)

7. Which of the following statements is most correct?

 a. A firm's business risk is solely determined by the financial characteristics of its
industry.
b. The factors that affect a firm's business risk are determined partly by industry
characteristics and partly by economic conditions. Unfortunately, these and other
factors that affect a firm's business risk are not subject to any degree of
managerial control.
c. One of the benefits to a firm of being at or near its target capital structure is that
financial flexibility becomes much less important.
d. The firm's financial risk may have both market risk and diversifiable risk
components.
e. None of the statements above is correct.

8. The residual distribution model minimizes new stock issues and flotation costs
because it considers the firm's capital structure.
a. True
b. False

9. This is a theory states that a company's dividend policy shall determine the
investment group it attracts.
a. Signaling Hypothesis
b. The Residual Distribution Model
c. Clientele Effect
d. Zero Growth model

10. According to this theory, firms will weigh the benefits gained from having a
favorable corporate tax rate against higher interest rates and bankruptcy costs
from taking on debt:
a. Modigliani - Miller Theorem
b. Signaling theory
c. Trade-off theory
d. None of the above.

11. Companies undertake stock splits and issue stock dividends to boost stock
prices beyond their optimal price range.
a. True
b. False

12. Modigliani and Miller state that in an efficient market, the following scenarios are
true, EXCEPT:
a. There is no bankruptcy cost
b. There are no taxes
c. Individuals enjoy lower interest rates than corporations
d. The use of debt does not impact earnings before interest and taxes,
13. This theory states that if a firm's future prospects are good, it should refrain from
issuing equity securities.
a. Modigliani - Miller Theorem
b. Signaling theory
c. Trade-off theory
d. None of the above.

14. This cash disbursement theory notes that if shareholders need cash, they can sell
their stocks at any time and use the dividend received to buy additional shares if
the company does issue dividends.
a. Dividend Irrelevance Theory
b. Bird-In-The-Hand Theory
c. Tax Preference Theory
d. Signaling Hypothesis

15. It is the use of borrowed money (debt) to finance the purchase of assets with the
expectation that the income or capital gain from the new asset will exceed the
cost of borrowing.
a. Financial leverage
b. Operating leverage
c. Financial risk
d. Business risk

16. Which of the following factors is likely to encourage a corporation to increase the
proportion of debt in its capital structure?
a. An increase in the corporate tax rate.
b. An increase in the personal tax rate.
c. An increase in the company's degree of operating leverage.
d. The company's assets become less liquid.

17. A 2-for-one stock split and the issuance of stock dividends dilute the companies
EPS.
a. True
b. False

18. A company will buy back its shares from shareholders due to the following
reasons EXCEPT:
a. The company is undergoing recapitalization.
b. The company plans to offer stock options to its employees.
c. The company is cash short.
d. The company's management sees that the stock is undervalued.

19. Which of the following factors would affect a company's business risk?
 a. The level of uncertainty regarding the demand for its product. b. The degree of
operating leverage.
b. The amount of debt in its capital structure.
c. Statements a and b are correct.
d. All of the statements above are correct.

20. Which of the following statements is correct regarding stock repurchases:

I. Increase shares outstanding, increase earnings per share. II. Decrease
shares outstanding and increase earnings per share. III. Decrease P/E ratio
and decrease stock price. IV. Decrease P/E ratio and increase the stock
price
a. I and III only.
b. II and IV only.
c. II and III only.
d. I and IV only.
 APPLICATION
Problem 1:
Financial analysts for Naulls Industries have revealed the following information about the
company:

● Naulls Industries currently has a capital structure that consists of 75 percent common
equity and 25 percent debt.
● The risk-free rate, rRF, is 5 percent.
● The market risk premium, rM - rRF, is 6 percent.
● Naulls’s common stock has a beta of 1.2.
● Naulls has 20-year bonds outstanding with an annual coupon rate of 12 percent and a
face value of $1,000. The bonds sell today for $1,200.
● The company’s tax rate is 40 percent.

1. What is the company's unlevered beta?

a. 0.43
b. 0.93
c. 1.0
d. 1.06

b = bu [1 + (1 - T) (D/S)]
1.2 = bu [ 1 + ( 1 - 0.40 ) (1,200 / (1,200/0.25 * 75) )
1.2 = bu [ 1.2 ]
bu = 1.2 / 1.2
bu = 1

Problem 2:
Rodriguez & Sons Co.anticipate that its net income at the end of the year will be $3.6 million
(before any recapitalization). The company currently has 900,000 shares of common stock
outstanding and has no debt. The company's stock trades at $40 a share. The company is
considering a recapitalization, where it will issue $10 million worth of debt at a yield to maturity
of 10 percent and use the proceeds to repurchase common stock. Assume the stock price
remains unchanged by the transaction, and the company's tax rate is 34 percent. What will be
the company's earnings per share, if it proceeds with the recapitalization?

2. What will be the company's earnings per share, if it proceeds with the
recapitalization?
a. 4.52
b. 2.45
c. 3.26
d. 2.23
 Net Income given na walang recapitalization → work back to EBIT
EBIT = 3,600,000 / (1 - 0.34)
EBIT = 5,454,545

Shares to be repruchased: 10,000,000 / 40 = 250,000 shares

EPS = (5,454,545 - (0.10 * 10,000,000)) * ( 1 - 0.34)

900,000 - 250,000
EPS = 4.52

Problem 3:
Stewart Inc. has $4,000,000 in total assets. The company’s current capital structure consists of
25 percent debt and 75 percent common equity. Currently, the company’s before-tax cost of
debt is 8 percent. The risk-free rate (rRF) is 5 percent and the market risk premium (rM – rRF) is
also 5 percent. At the firm’s current capital structure, the company’s beta is 1.15 (i.e., its current
cost of common equity is 10.75 percent). Stewart’s operating income (EBIT) is $300,000, its
interest expense is $80,000, and its tax rate is 40 percent. The company has 80,000
outstanding shares of common stock. The company’s net income is currently $132,000, and its
earnings per share (EPS) is $1.65.

3. What is the company's WACC?

a. 6.29%
b. 8.86%
c. 9.26%
d. 10.06%

rs = 0.05 + (0.05) 1.15

rs = 0.1075 - given na din pala hahahaha

WACC = 0.25 * (0.60) * 0.08 + 0.75 * 0.1075

WACC = 0.012 + 0.080625
WACC = 0.092625 or 9.26 %

4. What is Stewart Inc's current times-interest earned ratio?

3.75
TIE : 300,000 / 80,000 = 3.75
The company pays out all of its earnings as dividends (EPS = DPS), and hence its growth rate
is zero.

5. What is the company's stock price?

a. 15.3488
b. 15.3688
c. 15.3500
d. 15.3712

P0 = div1 / rs
P0 = 1.65 / 0.1075
P0 = 15.3488

Problem 4:
An analyst has collected the following information regarding the Huni Sinirangan Corporation:

● Total assets = $100 million.

● Basic earning power (BEP) = 20%.

● Tax rate = 40%.

Currently, the company has no debt or preferred stock and its interest expense and preferred
dividends equal zero. The book value and market value of common equity equals $100 million.
The company has 5 million outstanding shares of common stock, and its stock price is $20 a
share.

Huni Sinirangan is considering a recapitalization, where they will issue $20 million of debt and
use the proceeds to buy back common stock at the current price of $20 a share. As a result of
the recapitalization, the size of the firm will not change. Assume that the newly-issued debt will
have a before-tax cost of 8 percent. Assume that the recapitalization will have no effect on the
company’s basic earning power

6. Assume that after the recapitalization the company's times-interest-earned ratio

will be 12.5. What will be Huni Sinirangan's expected earnings per share following
the recapitalization?
a. $2.44
b. $2.62
c. $2.76
d. $2.80
 TIE = EBIT / Interest Expense
12.5 = EBIT / (20,000,000 * 8%)
EBIT = 20,000,000

Buyback shares: 20,000,000 / 20 = 1,000,000 shares

EPS = (20,000,000 - (20,000,000 * 0.08)) * ( 1 - 0.40)

5,000,000 - 1,000,000
EPS = $2.76

Problem 5:
DMV Corporation has 1,500,000 shares authorized at P5 par value as of Jan 1, 2021. is Out of
the authorized shares, 1,250,000 are issued and outstanding. On March 31, the board of
directors has approved to buy back their own shares in the market. For this purpose, they
issued bonds and raised P 5 million in debt. On the day of the purchase, the market price of
DMV Corporation shares was at 10 per share.

7.
a. No effect on number shares outstanding; decrease in the number of shares
issued by 500,000.
b. Decrease in number of shares outstanding by 500,000; no effect on the
number of shares issued.
c. No effect on the number of shares outstanding; no effect on the number of
shares issued
d. Decrease in both number of shares issued and outstanding by 500,000

Buyback: 5,000,000/ 10 = 500,000 shares to buyback thus decreasing the

shares outstanding but no effect on shares issued

Problem 6:
MVS Holdings Corp has 1,000,000 shares authorized and 700,000 shares issued and
outstanding at P 5 par value as of Jan 1, 2021. The Board of Directors has unanimously agreed
to undertake a 2 for 1 stock split effective Jun 1, 2021. Based on this information, what is the
effect of the 2-for-1 split on the number of shares authorized and the par value after the split?

8. Based on this information, what is the effect of the 2-for-1 split on the number of
shares authorized and the par value after the split?
a. Outstanding shares and the stock price will double.
b. Outstanding shares and the stock price will decrease by half.
c. Outstanding shares will double and the stock price will decrease in half.
d. Outstanding shares will decrease by half and the stock price will double.
Problem 7:
DMV Corporation has 1,500,000 shares authorized at P5 par value as of Jan 1, 2021. is Out of
the authorized shares, 1,250,000 are issued and outstanding. On March 31, the board of
directors has approved to buy back their own shares in the market. For this purpose, they
issued bonds and raised P 5 million in debt. On the day of the purchase, the market price of
DMV Corporation shares was at 10 per share.

9. How many treasury shares have been bought based on the information above?
500,000
Buyback: 5,000,000/ 10 = 500,000 shares

Problem 8:
MCM Hotel has 1,000,000 shares authorized and 250,000 shares issued and outstanding at P 2
par value as of Jan 1, 2021. On June 30, 2021, the board declared 20% stock dividends to
holders of record as of July 31, 2021, which will be paid on September 15, 2021.

10. On September 30, 2021, how much MCM shares will be outstanding?
300,000 - questionable
250,000 * 1.20 = 300,000 will be the new outstanding shares

However, questionable because the stated question is “how much” pero yung 300,000 is
yan yung dami ng outstanding shares

Problem 9:
MCM Hotel has 1,000,000 shares authorized and 250,000 shares issued and outstanding at P 2
par value as of Jan 1, 2021. On June 30, 2021, the board declared 20% stock dividends to
holders of record as of July 31, 2021, which will be paid on September 15, 2021.

11. What is the value of the outstanding shares as of Jan 1, 2021?

500,000
250,000 * 2 = 500,000

Problem 10:
BP Inc. would like to use the residual distribution model to calculate the distribution for the year.
Per the CFO, the company will require P 15 million to finance the purchase of a new lot The
business uses 40% debt and 60% equity to finance its assets and would like to maintain the
ratio. The forecasted income for 2021 is at P 12 million.

12. How much can be paid as dividends for 2021?

3,000,000
Dividends: 12,000,000 - (15,000,000 * 60%) = 3,000,000
Problem 11:
RF Corp. would like to use the residual distribution model to calculate the distribution for the
year. Per the CFO, the company will require P 5 million to finance the construction of their new
office. The business uses 50% debt and 50% equity to finance its assets and would like to
maintain the ratio. The forecasted income for 2021 is at P 14 million. Of the total amount for
distribution, RF Corp targets a to pay 20% in cash dividends while the rest is to be used to
repurchase stocks.

13. How much of the total distributable amount can be allocated to the repurchase of
treasury shares?
9,200,000
Income for distribution: 14,000,000 - (5,000,000 * 50%) = 11,500,000
Allocated for treasury shares: 11,500,000 (1 - 0.20) = 9,200,000

Problem 12:
MVS Holdings Corp has 1,000,000 shares authorized and 700,000 shares issued and
outstanding at P 5 par value as of Jan 1, 2021. The Board of Directors has unanimously agreed
to undertake a 2 for 1 stock split effective Jun 1, 2021.

14. If you own 20,000 shares on Apr 30, 2021, and held it through the end of the year,
what is the net effect of the total value of the shares you are holding as of
December 31, 2021?
0

Problem 13:
BP Inc. would like to use the residual distribution model to calculate the distribution for the year.
Per the CFO, the company will require P 15 million to finance the purchase of a new lot The
business uses 40% debt and 60% equity to finance their assets and would like to maintain the
ratio. The forecasted income for 2021 is at P 12 million.

15. How much is the payout ratio?

25
Payout Ratio = Div / Net income
Payout Ratio: [12,000,000 - (15,000,000 * 60%)] / 12,000,000 = 0.25 or 25
Problem 14:
RF Corp. would like to use the residual distribution model to calculate the distribution for the
year. Per the CFO, the company will require P 5 million to finance the construction of their new
office. The business uses 50% debt and 50% equity to finance its assets and would like to
maintain the ratio. The forecasted income for 2021 is at P 14 million. Of the total amount for
distribution, RF Corp targets a to pay 20% in cash dividends while the rest is to be used to
repurchase stocks.

16. What percentage of the net income comprises the amount set aside for dividend
distribution?
16.43

For Distribution: 14,000,000 - (5,000,000 * 50%) = 11,500,000

Dividends: 11,500,000 * 20% = 2,300,000

Percentage: 2,300,000 / 14,000,000 = 16.43%

Problem 15:
Company RSY's EBIT increased by 8.58% from 2018 to 2019, and its sales increased by 6.04%
during the same period. Compute for the degree of operating leverage.

17. Compute for the degree of operating leverage

1.4206 - rounding off chenes
DOL: 0.0858 / 0.0604 = 1.42052980132

Problem 16:
Marlyn Hardware is contemplating fabricating new metal sheets with anti-corrosion properties.
She projects that she can sell 70,000 units at P 150 per sheet in the first year. She incurs a
fixed cost of P 5,000,000 for the factory and incurs a variable cost of P 50 per sheet produced.
She would like to know how a 10% increase in her sales will impact her net income. Calculate
the degree of operating leverage.

18. Calculate the degree of operating leverage.

3.5

First year Second year change%

Sales 10,500,000 11,550,000 10%
VC (3,500,000) (3,850,000) 10%
CM 7,000,000 7,700,000 10%
FxdC (5,000,000) (5,000,000)
EBIT 2,000,000 2,700,000 35%

DOL: 35% / 10% = 3.5

Problem 17:
Royal Lilly Incorporated wants to expand its operations by opening up a second plant to
produce its new line of furniture. Its CFO is contemplating taking on debt to fund the expansion.
In the last year, the business had no debt and earned P 4 million before interest and taxes. This
year the management is considering borrowing P 20 million at a 6% interest rate per year.
Calculate the degree of financial leverage for Royal Lilly Incorporated.

19. Calculate the degree of financial leverage for Royal Lilly Incorporated.
1.43

DFL = EBIT / (EBIT - Interest)

DFL = 4,000,000 / [4,000,000 - (20M * 6%) ]
DFL = 1.43

Problem 18:
RAF Corporation is a manufacturing company engaged in the process of manufacturing printer
ink cartridges. As its comptroller, you were asked to analyze the sales projection at the base
sales of 20,000 units and at 25,000 units and was given the following data:

20. Calculate the degree of financial leverage for RAF Corporation.

1.84

DFL = EBIT / (EBIT - Interest)

DFL = 1,150,000 / (1,150,00 - 525,000)
DFL = 1.84
 CA51021: Financial Markets
QUIZ 4: Derivatives and Forex

THEORIES
1. You find that an investor purchases a put option on shares of Company Z stock.
The most likely reason that an investor would make such a purchase is because
Company Z's stock price will randomly increase.
a. True
b. False

2. An increase in the length to expiration for a call option will cause a decrease in
the value of the respective derivative.
a. True
b. False

3. According to the Black and Scholes option pricing model, an increase in the risk
free rate will lead to an increase in the value of a call option
a. True
b. False

4. A floating interest rate is advantageous in an increasing interest rate in the

market.
a. True
b. False

5. Purchasing Power Parity implies that if the law of one price holds at all times then
differences in interest rates are associated with expected changes in exchange
rates.
a. True
b. False

6. You need to immediately purchase 100 shares of Stock X and you own a call
option with a strike price of $32. The current price of Stock X is $25. Your best
course of action is to purchase the stock in the market at a price of $25.
a. True
b. False

7. The supply-demand relationship involving two currencies is said to be in balance

at the spot exchange rate.
a. True
b. False
8. The market value of an option is typically higher than its exercise value due to the
speculative nature of investment.
a. True
b. False

9. Interest rate parity states that the currency of a country with relatively higher
interest rate will depreciate relative to the currency of a country with a relatively
lower interest rate.
a. True
b. False

10. Forward contracts are generally standardized instruments, whereas futures

contracts are generally tailor-made for the 2 parties of the contract.
a. True
b. False

11. LEAPS are very short-term options that have begun trading on the exchanges in
recent years.
a. True
b. False

12. Transportation costs, import taxes, and transaction costs may prevent purchasing
power parity from holding across different countries.
a. True
b. False

13. One of the main reasons for the name "derivatives" is that the instruments derive
their value from the value of other instruments.
a. True
b. False

14. A nation with relatively lower interest rate levels than other countries will have a
relatively stronger currency.
a. True
b. False

15. The futures market can be used to guard against interest rate and input price risk
through the use of hedging.
a. True
b. False

16. Interest rate parity states that a country with a relatively higher expected inflation
rate will have its currency depreciate relative to a country with a relatively lower
inflation rate.
 a. True
b. False

17. The option that gives the owner the right to buy an asset at a fixed price at or
before a certain date is called a call option.
a. True
b. False

18. When a call option's strike price is less than the current price of the underlying
asset, the call is said to be out of the money.
a. True
b. False

19. The direct quotation method expresses the number of foreign currency units
needed to buy one U.S. dollar.
a. True
b. False

20. According to the Black-Scholes option pricing model, a higher strike price has the
effect of decreasing the value of a call option.
a. True
b. False

APPLICATION
1. Suppose 144 yen could be purchased in the foreign exchange market for one U.S.
dollar today. If the yen depreciates by 8.0% tomorrow, how many yen could one
U.S. dollar buy tomorrow?
a. 155.5200 = 144 * 1.08
b. 163.2960
c. 171.4608
d. 180.0338

2. Crown Honda purchased one of its most popular models for 965,600 yen. The
exchange rate for the yen was 142 yen per U.S. dollar at the time of purchase but
then rose to 171.8 yen by the time payment was made. What was the dealer's gain
or loss on the change in rates?
a. gain of $1,180 = 965,600 * ( 1 / 171.8 - 1 / 142 ) ; dealer paid less
b. loss of $1,427
c. loss of $1,180
d. gain of $1,427
3. Bill Henricksen, purchased a put option on Cycle Inc. for $4. The put option has a
strike price of $40 and currently Cycle Inc. shares trade for $44. The expiration
date of the option is 6 months from today. What is Henricksen's maximum gain on
his put option?
a. $4
b. $36
c. $40
d. $44

4. A call option on Dani Corp. is trading for $4.50. The strike price of the option is
$25 and it has an expiration of 3 months. If the stock of Dani Corp. is trading at
$28, how much of the option premium is attributed to intrinsic value?
a. $1.5
b. $3.0
c. $4.5
d. $5.0

5. Suppose a CBOT 10-year U.S. Treasury note futures contract has a quoted price
of 88-30. If annual interest rates go down by 1.00 percentage point, what is the
gain or loss on the futures contract? (Assume a $1,000 par value, round the new
interest rate to 4 decimal places when written as a decimal, and round the change
in price up to the nearest whole dollar.)
a. $63.00
b. $65.00
c. $67.00
d. $69.00

Can be solved by using hypothetical values and based on the lecture of Sir Timbang

88 30/32 = 88.9375

1,000 * (88.9375 / 100) = 889.375

AYTM - Approximate Yield To Maturity

Assuming 1,000 par value, 6% payable semi annually for 10 years
 AYTM = 30 + [ (1,000 - 889.375)/ 20 )
1,000 ( 0.40) + 889.375 (0.60)
2
AYTM = 0.0761

Interest rate go down by 1% what will be the gain or loss: 0.0761 - 0.01 = 0.0661

PV of 1,000 with new interest = FV(1 + i)-n + CP 1- (1 + i)-n

i
PV = 1,000(1.0330) -20
+ 30 1 – (1.0330) -20

0.0330
PV = 956.5807

Compare now to 889.375

956.5807 - 889.375 = 67.21 or 67

6. You need to find the price of a European call option on a stock that does not pay
dividends. The current price of the shares are $50 and the strike price on the
option is $50. The expiration date is 3 months from now and the risk-free rate
applicable is 10% per annum. If the standard deviation of the returns on the stock
is 20%, what is the price of a single call option?
a. $6.53
b. $2.91
c. $2.65
d. $2.00
7. Suppose that J.B. Campbell & Company operates in the United States and sells 10
coffee tables to a Japanese company. J.B. Campbell & Company delivers the
tables now and will receive ¥187,500 in 6 months. If the current spot rate is ¥122/$
and if the exchange rate in 6 months is ¥127/$, how much will J.B. Campbell &
Company have gained/lost from the movements in exchange rates if it does not
hedge this transaction.
a. $60.50
b. ($60.50) = 187,500 * ( 1 / 127 - 1 / 122) ; the value of payment goes down
c. ¥7,684.43
d. (¥7,684.43)

8. A box of candy costs 28.80 Swiss francs in Switzerland and $20 in the United
States. Assuming that purchasing power parity (PPP) holds, how many Swiss
francs are required to purchase one U.S. dollar?
a. 0.9448
b. 1.0498
c. 1.1664
d. 1.4400 = 28.80 / 20

9. The annualized rate of interest on three-month government bonds is 7% in Italy

and the annualized rate on three-month government bonds is 4% in the United
States. The current spot rate is $1.12/€. Using interest rate parity what is the
implied three-month forward rate between the U.S. dollar and the Euro.
a. 1.01
b. 1.0175
c. 1.1035
d. 1.12 1.1117 = 1.12 * ( 1.01 / 1.0175)

10. Looking at The Business Journal you observe that the settlement price on a
hypothetical 10-year, semiannual payment, 6% coupon Treasury note is 105-21. If
the note has a $1,000 par value, what is the implied Treasury note rate?
a. 5.27%
b. 5.53%
c. 5.80%
d. 6.10%

Can also be solved with excel

Assume again 1,000 par, 6% rate paid semi annually for 10 years

105 21/32 = 105.65625

1,000 * (105.65625) = 1,056.5625 ; Put this value in the excel as negative

1,000 * 6% * 6/12 = 30 ; semi annual rate
1,000 + 30 = 1,030 last payment
 After getting the percentage since it is the rate for semi annual payment, multiply it by
two

2.6326% * 2 = 5.27%

11. You need to find the price of a European call option on a stock that does not pay
dividends. The current price of the shares are $100 and the strike price on the
option is $80. The expiration date is 9 months from now and the risk-free rate
applicable is 8% per annum. If the standard deviation on the returns on the stock
is 50%, what is the price of a single call option? (d1 = 0.87040, N(d1) = 0.807959,
d2 = 0.43739, N(d2) = 0.669084)
a. $19.71
b. $27.20
c. $30.39
d. $36.65
12. Suppose 90-day investments in Britain have a 6% annualized return and a 1.5%
quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4%
annualized return and a 1% quarterly (90-day) return. In the 90-day forward market,
1 British pound equals $1.65. If interest rate parity holds, what is the spot
exchange rate ($/£)?
a. $1.4924
b. $1.6582 = 1.65 * ( 1.015 / 1.01) - spot rate pala hanap sorryy
c. $1.8240
d. $2.0064

13. A 6-month put option on FLT's stock has a strike price of $45 and sells in the
market for $8.90. FLT's current stock price is $41. What is the exercise value of the
option?
a. $2.62
b. $2.92
c. $3.24
d. $4.00 = 45 - 41

14. A product sells for $750 in the United States. The spot exchange rate is $1 to 1.65
Swiss francs. If purchasing power parity (PPP) holds, what is the price of the
product in Switzerland?
a. 295.45
b. 454.55
 c. 750.00
d. 1,237.50 = 750 * 1.65

15. Ms. Katigbak bought stocks of Ayala Land Inc. (ALI) that currently sells at P120. A
call option on the stock with an exercise price of P110 and time until expiration
has a market value of P20. On the other hand, a put option on ALI’s stock has a
market value of P6.00 and with an exercise price similar to call option. Ms.
Katigbak forecasted that at the expiration of the options, the stock price will either
be P50 or P140 with equal probability. (Instructions: Do not round-off during the
process of answering the problems. Rounding-off should only be done in your
final answer. Do not put any currency sign, percentage or units. units. Write your
answers in the following format: 1.00, 1.21, 0.25, 100,000.00’ 100,000.25, 12.50%
should be written as 12.50, and 0.65% should be written as 0.0065.)

What is the premium associated with the put option?

6.00

CSP Exer P Exer V Market V Option

Premium
Put option 120 110 0 6 6

16. Ms. Katigbak bought stocks of Ayala Land Inc. (ALI) that currently sells at P120. A
call option on the stock with an exercise price of P110 and time until expiration
has a market value of P20. On the other hand, a put option on ALI’s stock has a
market value of P6.00 and with an exercise price similar to call option. Ms.
Katigbak forecasted that at the expiration of the options, the stock price will either
be P50 or P140 with equal probability.

If ALI’s stock price increases to P140, what would be the return to the investor
who bought the call option of the stock?
50 or 0.50

Put option Return = [(140 - 110) / 20] - 1

= 0.50 or 50%

17. Ms. Katigbak bought stocks of Ayala Land Inc. (ALI) that currently sells at P120. A
call option on the stock with an exercise price of P110 and time until expiration
has a market value of P20. On the other hand, a put option on ALI’s stock has a
market value of P6.00 and with an exercise price similar to call option. Ms.
Katigbak forecasted that at the expiration of the options, the stock price will either
be P50 or P140 with equal probability.

If ALI’s stock price increases to P100, what would be the return to the investor
who bought the put option of the stock?
 66.67 or 0.6667

Call option return = [(110 - 100) / 6] - 1

= 0.6667 or 66.67%

18. The direct quotes for euros and British pounds are $.90 and $1.50, respectively.
What is the cross-rate between euros and pounds expressed in units of pounds
per euro?
0.60

$0.90 * $1.50 = pound

Pound euro euro
0.60 = pound/ euro

19. Suppose that a United States firm is considering an investment that will yield cash
flows in Canadian dollars. The projects cash flows will be the following: Initial
cost = C$-1,000,000, Year 1 = C$550,000, Year 2 = C$340,000, Year 3 = C$125,000.
The U.S. firm plans to evaluate the project by discounting the cash flows at the
Canadian cost of capital of 7% and then converting the NPV back to U.S. dollars at
the current spot rate which is $0.8213/C$.
-71,433

Eto sagot if NPV hinahanap

Year 1 PV: 550,000 * (1/(1.07)^1) = 514,018.69
Year 2 PV: 340,000 * (1/(1.07)^2) = 296,969.17
Year 2 PV: 125,000 * (1/(1.07)^3) = 102,037.23
TOTAL 913,025.09
Compare to initial cost 1,000,000
(86,979.91)
Convert * 0.8213
Answer (71,432) rounding off diff

20. Smith Enterprises stock currently sells for $17.50. A put option on the stock has a
strike price of $15 and currently sells at $4.50. (Instructions: Do not round-off
during the process of answering the problems. Rounding-off should only be done
in your final answer. Do not put any currency sign, percentage or units. units.
Write your answers in the following format: 1.00, 1.21, 0.25, 0.00, 100,000.00’
100,000.25, 12.50% should be written as 12.50, and 0.65% should be written as
0.0065.)
0