Agency Costs Are An Integral Part Of Agency Relationships

Q1. Agency costs are am integral part of agency relationships. They are a key concern in the shareholder management relationship in that:

• agency costs result in a reduction in the value of the company, because management pursues its own interests
• establishment of agency relationships requires extensive legal and contractual arrangements, which can be very costly.
• agency costs result in a reduction in the value of the company, because of the administration costs in establishing agencies.
• shareholders view a company that operates as an agent to other companies as being more risky and therefore, they are willing to pay less for sharesin the company

Q2. An investment decision is distinct from a financing decision in that:

Select one:

• investment decisions relate to reviewing past investment programs, while financing decisions relate to funding new investments.
• investment decisions are about deciding on which new investments should be undertaken, and reviewing past investments, while financing decisions consider how to fund the capital needs of the investment program.
• financing decisions relate to choices about the firm’s financial asset base, while investment decisions relate to choices about physical assets.
• financing decisions consider which is the best investment to undertake, while investment decisions consider the list of possible investments that can be made.

Q3. Most financial intermediaries issue _____financial claims and purchase ________financial claims.

• indirect; indirect
• indirect; direct
• direct; direct
• direct; indirect

Q4. Systematic risk:

• measures a share portfolios tendency to vary relative to the market as a whole.
• is a risk that exists because the value of an item being hedged may not always keep the same price relationship to contracts purchased or sold in the futures markets.
• none of the above responses are correct.
• measures the tendency of a share’s price to change because of factors particular to that specific share.

Q5. Commercial bills may be classified as bank bills or non-bank bills. Which of the following is correct?

• The classification depends only on whether the acceptor of the bill is a bank or a non-bank.
• A bill that is accepted or endorsed by a bank is a bank bill.
• A bill accepted by a building society or an investment bank is a bank bill.
• The classification depends on whether the drawer of the bill is a bank or a non-bank.

Q6. The expectations theory of the term structure of interest implies that:

• there is a risk that borrowers may default on the payment of the principal.
• interest received on securities is in accordance with term to maturity.
• there is a premium due to uncertainty about the future level of interest rates.
• bond investors can expect to achieve the same return over any future period, regardless of the security in which they invest.

Q7. Given a perfect capital market and perfect certainty, the firm will always undertake a project where:

• the future rate of return on the project is greater than the interest rate available in the capital market.
• the current rate of return on the project is less than the return available on projects undertaken by competitors.
• the future rate of return on the project is less than the interest rate available in the capital market.
• the current rate of return on the project is greater than the opportunity cost of forgone consumption.

Q8. To calculate a project’s net present value (NPV), the project’s required rate of return is used to:

• convert future cash flows to their equivalent values today.
• convert the non-operating cash flows into operating cash flows.
• compound cash flows to their future values.
• compute the weighted average cost of capital to discount the cash flows.

Q9. A problem with estimating the cost of capital for a project using the CAPM derived from market data is that:

• the estimate for standard deviation is not obtainable.
• it is not possible to estimate systematic risk from market data.
• a value for the risk-free rate of interest is not available.
• individual investment projects are not traded on a stock exchange.

Q10. The ultimate objective of investment and financing decisions is to maximize:

• the number of projects the company is invested in.
• the amount added to the value of the owner’s wealth.
• the repayments that are made of debt.
• the salaries of all employees of the firm.

Q11. The interest rate where interest is charged at the same frequency as the quoted interest rate is the:

• nominal interest rate.
• effective interest rate.
• compound interest rate.
• real interest rate.

Q12. An annuity in which the first cash flow is to occur after a time period that exceeds the time period between each subsequent cash

• annuity due
• growth annuity.
• ordinary annuity.
• deferred annuity.

Q13. You have a choice between receiving $500 now and $530 in six months’ time. Current interest rates are 10% p.a. (simple interest). As a rational investor, which option would you choose and why?

• $530 in six months’ time, because $500 invested for six months is only worth $525.
• $500 now, because you have the option to invest or consume goods.
• $500 now, because receiving $530 in six months’ time is equivalent to earning only 6% interest, whereas in the bank you can earn 10% interest.
• $500 now, because it would be worth $550 in six months’ time.

Q14. Which of the following statements best describes the concept used to value shares?

• The value of an infinite stream of dividends discounted by the current short-term interest rate assuming a company has an infinite life.
• The present value of the dividend stream and expected capital gain must be calculated separately and then added together.
• Market price can be expressed as the present value of an infinite stream of dividends.
• Market price can be expressed as the present value of an infinite stream of dividends assuming a company has an infinite life.

Q15. Which of the following two investments would a risk seeker choose: Investment A with an expected outcome of $1000 and standard deviation of $500, or Investment B with an expected outcome of $1000 and standard deviation of $200?

• Investment A because if Investment B is chosen the expected utility from the increase in spread of expected returns below $1000 outweighs the expected utility from the increase in spread of expected returns above $1000.
• Investment A because it offers the chance of more wealth.
• Investment A because the downside risk is greater.
• Investment B because the downside risk is less.

Q16. According to portfolio theory, which of the following assumptions is not essential to the equilibrium pricing of risky assets?

• All investors can sell short assets (sell an asset first and then purchase later).
• All investors have the same estimate of expected returns and variance of expected returns on each asset.
• All assets are traded in perfect markets.
• All investors have a common single-period time horizon for investment decisions.

Q17. The major difference between investing institutions and financial intermediaries is that:

• financial intermediaries generally have a much wider spread of assets than investing institutions.
• investing institutions accept money from the public and invest the funds in assets, while financial intermediaries merely act as a third party and oversee the transfer of funds.
• investing institutions are not required to pay tax under the current Australian tax system.
• the major role of financial intermediaries is to accept deposits and make loans while investing institutions are directed towards providing insurance and funds management.

Q18. Securitisation is the process of:

• converting tradeable securities into illiquid assets such as bank loans.
• hiring underwriters to ensure share issues are fully subscribed.
• only lending and/or investing with companies that have an AAA credit rating
• making assets marketable by aggregating income-producing assets in a pool and issuing new securities backed by the pool.

Q19. The term to ‘underwrite’ refers to:

• insurance offered by banks against changes to mortgage interest rates.
• a type of insurance that is offered by brokers to investors for protection against capital loss.
• an agreement by a broker to buy a portion of shares that are to be issued.
• a legal contract binding both the seller and buyer of shares against potential loss.

Q20. Why do banks often act as intermediaries to obtain funds for companies from overseas?

• Borrowing funds from overseas sources is risky, and where a bank acts as an intermediary they bear all the default and foreign exchange risk.
• It is illegal for companies to obtain funds from abroad unless they are listed as a financial intermediary with APRA.
• They typically have high credit ratings and hence are better placed to borrow money overseas than many companies.
• Because borrowers want to minimise their tax obligation.

Q21. During the global financial crisis investment banks faced greater pressure as:

• a consequence of higher leverage and exposure to impaired assets.
• the ability to provide illiquidity.
• increasing equity prices of financial institutions.
• as a result of all of the given answers.

Q22. The process of securitisation such as issuing residential mortgage-backed securities (RMBS) allows financial institutions to:

• none of the given answers.
• fund lending directly.
• fund lending indirectly through the capital market.
• creates deposits.

Q23. A market where previously issued securities are traded is known as:

• liquid market.
• secondary market.
• primary market.
• seasoned market.

Q24. The net present value method of project evaluation is preferred to the internal rate of return method because:

• the internal rate of return method may give multiple rates of return or zero rates of return in some cases, but not for mutually exclusive projects.
• the internal rate of return method yields net present value profiles that do not intersect for mutually exclusive projects.
• the internal rate of return method may give an inconsistent ranking due to the magnitude or timing of cash flows.
• most projects are independent rather than mutually exclusive.

Q25. Which of the following statements is false?

• Accepting a project with an internal rate of return greater than the required rate of return should result in a positive net present value.
• Accepting a project with an internal rate of return less than the required rate of return should result in a negative net present value.
• Accepting a project with an internal rate of return equal to the required rate of return should result in an increase in a firm’s share price.
• Accepting a project with an internal rate of return greater than the required rate of return should result in an increase in a firm’s share price.

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