Part 2 Risk and Return Raising Capital Corporate Restructuring and Bankruptcy_Sol 20 Jan 2024

12/29/23, 11:07 AM CMA Exam Review - Part 2 - Assessment Review
Question 1
2.B.1.h
aq.cap.ass.0001_1710
LOS: 2.B.1.h
Lesson Reference: Capital Asset Pricing Model
Difficulty: medium
Bloom Code: 3
If the Fed caused the risk-free rate to increase, we would expect the cost of capital to:
Correct
increase.
decrease.
Your Answer
remain unchanged.
Need more information to answer question.
Rationale
 increase.
An increase in the risk-free rate will cause the cost of equity to increase using the CAPM (capital asset pricing model) approach. It would also most
likely cause the cost of raising new debt to increase as market rates increase based on the increase in the Fed Funds rate.
Rationale
 decrease.
A decrease in the risk-free rate would be needed in order to cause the cost of equity to decrease using the CAPM approach.
Rationale
 remain unchanged.
The CAPM approach specifies that changes in the risk-free rate cause changes in the cost of capital.
Rationale
 Need more information to answer question.
Enough information is provided to draw inferences from the CAPM.
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Question 2
2.B.1.g
2B1-LS19
LOS: 2.B.1.g
Difficulty: medium
Bloom Code: 3
Which one of the following would have the least impact on a firm's beta value?
*Source: Retired ICMA CMA Exam Questions.
Industry characteristics
Correct
Payout ratio
Operating leverage
Debt-to-equity ratio
Rationale
 Industry characteristics
This answer is incorrect. Industry characteristics would not have the least impact on a firm's beta value.
Rationale
 Payout ratio
Payout ratio is the amount of earnings paid out as dividends to shareholders. The payout ratio is computed by taking dividends per share and
dividing by earnings per share. This ratio will not affect the firm's beta value as it does not increase nor decrease the risk of the firm.
Rationale
 Operating leverage
This answer is incorrect. Operating leverage would not have the least impact on a firm's beta value.
Rationale
 Debt-to-equity ratio
This answer is incorrect. Debt-to-equity ratio would not have the least impact on a firm's beta value.
Question 3
2.B.5.g
aq.eval.bc.0005_1710
LOS: 2.B.5.g
Lesson Reference: Evaluating Business Combinations
Difficulty: medium
Bloom Code: 3
Which of the following is not a common reason that business combinations take place?
Increase revenue
Decrease costs
Expand market share

Correct
Government regulation
Rationale
 Increase revenue
Business combinations often result in revenue-generation synergies.
Rationale
 Decrease costs
Business combinations often result in cost-saving synergies.
Rationale
 Expand market share
Business combinations often result in a firm having greater market share.
Rationale
 Government regulation
Government regulation often prohibits business combinations. It does not mandate the firms be combined.
Question 4
2.B.5.g
tb.eval.bc.002_1805
LOS: 2.B.5.g
Difficulty: easy
Bloom Code: 2
Which of the following statements is true of the business valuation principle?
The value of a business does not change over time.
The value of a business is solely affected by managers’ financing decisions.

Correct
The fair market value of a business is the value of that business to a hypothetical person who is knowledgeable about the business.
Estimating the fair market value of a business always includes the value of synergies or the effects of any investor-specific management style.
Rationale
 The value of a business does not change over time.
Incorrect. The value of a business depends upon future events like cash flows and dividends, which can change over time.
Rationale
 The value of a business is solely affected by managers’ financing decisions.
Incorrect. Many things affect the value of a business other than managers’ financing decisions, such as dividend policy and cash flows.
Rationale
 The fair market value of a business is the value of that business to a hypothetical person who is knowledgeable about the business.
Correct. Different investors care about different attributes (dividends, growth, low risk) and use different models to estimate the value of the firm to
them.
Rationale
 Estimating the fair market value of a business always includes the value of synergies or the effects of any investor-specific management
style.
Incorrect. Synergies and investor-specific management style are important, but hard to quantify when calculating the value of a business.
Question 5
2.B.1.h
tb.cap.ass.004_1805
LOS: 2.B.1.h
Difficulty: medium
Bloom Code: 3
TeleNyckel Inc. has a beta of 1.4 and is trying to calculate its cost of equity capital. If the risk-free rate of return is 9% and the market risk premium is 5%,
then what is the firm's after-tax cost of equity capital if the firm's marginal tax rate is 30%?
11.20%
Your Answer
12.60%
7.00%
Correct
16.00%
Rationale
 11.20%
Incorrect. Since dividends are not tax deductible, the cost of equity capital is not adjusted for after-tax effects. This answer is correctly calculated by
the capital asset pricing model, the cost of equity is .09 + 1.4 × .05 = .16. However, this answer then incorrectly multiplies .16 by one less the tax rate,
so .16 × (1 − .3) = 11.2%.
Rationale
 12.60%
Incorrect. The cost of equity capital is not the beta multiplied by the risk-free rate. This is incorrectly calculated as 1.4 × 9% = 12.6%.
Rationale
 7.00%
Incorrect. The cost of equity capital is not the beta multiplied by the market risk premium. This is incorrectly calculated as 1.4 × 5% = 7%.
Rationale
 16.00%
Correct. Using the capital asset pricing model, the cost of equity is .09 + (1.4 × .05) = .16. There is no need to adjust for the tax rate because dividends
are not tax deductible. Also, note that the question prompt provided the market risk premium, not the market rate of return. The market risk
premium represents the (Rm − Rf) portion of the CAPM equation.
Question 6
2.B.1.d
2B1-AT06
LOS: 2.B.1.d
Lesson Reference: Calculating Return
Difficulty: medium
Bloom Code: 3
The expected rate of return for the stock of Cornhusker Enterprises is 20%, with a standard deviation of 15%. The expected rate of return for the stock of
Mustang Associates is 10%, with a standard deviation of 9%. The stock that would be considered riskier is:
Mustang because the standard deviation is higher.
Correct
Mustang because the coefficient of variation is higher.

Your Answer
Mustang because the return is lower.
Cornhusker because the coefficient of variation is lower.
Rationale
 Mustang because the standard deviation is higher.
This answer is incorrect. Mustang would be considered the riskier stock, but not because the standard deviation is higher.
Rationale
 Mustang because the coefficient of variation is higher.
The coefficient of variation can be used to measure relative risk. The coefficient of variation is calculated by dividing the standard deviation by the
expected return.
Coefficient of variation = σ/¯R̄

¯
where:
σ = standard deviation
¯
¯
R̄ = expected return
Coefficient of variation for Mustang = 0.09 / 0.1 = 0.9
Coefficient of variation for Cornhusker = 0.15 / 0.2 = 0.75
Therefore, the stock of Mustang is riskier than the stock of Cornhusker, because its coefficient of variation is higher.
Rationale
 Mustang because the return is lower.
This answer is incorrect. Mustang would be considered the riskier stock, but not because the return is lower.
Rationale
 Cornhusker because the coefficient of variation is lower.
This answer is incorrect. Cornhusker would not be considered the riskier stock because the coefficient of variation is lower.
Question 7
2.B.1.g
2B1-LS15
LOS: 2.B.1.g
Difficulty: medium
Bloom Code: 3
According to the capital asset pricing model (CAPM), the expected risk premium of a portfolio varies:
based on investor attitudes toward risk.
based on the number of securities in the portfolio.

Correct
in direct proportion to beta in a competitive environment.
in direct proportion to the prime interest rate.
Rationale
 based on investor attitudes toward risk.
This answer is incorrect. According to the capital asset pricing model (CAPM), the expected risk premium of a portfolio does not vary based on
investor attitudes toward risk.
Rationale
 based on the number of securities in the portfolio.
This answer is incorrect. According to the capital asset pricing model (CAPM), the expected risk premium of a portfolio does not vary based on the
number of securities in the portfolio.
Rationale
 in direct proportion to beta in a competitive environment.
The CAPM implies that the risk premium varies in direct proportion to beta in a competitive market. The expected risk premium for each investment
in a portfolio should increase in proportion to its beta. This means that all investments in a portfolio should plot along an upward sloping line,
known as the security market line.
Rationale
 in direct proportion to the prime interest rate.
This answer is incorrect. According to the capital asset pricing model (CAPM), the expected risk premium of a portfolio does not vary in direct
proportion to the prime interest rate.
Question 8
2.B.1.b
aq.types.risk.0005_1710
LOS: 2.B.1.b
Lesson Reference: Types of Risk
Difficulty: easy
Bloom Code: 2
Diversified equity portfolios eliminate which type of risk?
Correct
Unsystematic risk
Your Answer
Systematic risk
Market risk
Interest rate risk
Rationale
 Unsystematic risk
Diversified portfolios eliminate the risk from an individual company, or unsystematic risk.
Rationale
 Systematic risk
Systematic risk is not diversifiable.
Rationale
 Market risk
Market risk is not diversifiable.
Rationale
 Interest rate risk
Interest rate risk is the risk that market interest rates will vary and impact the value of interest-bearing securities, typically related to debt and not
equity.
Question 9
2.B.2.x
types.risk.tb.020_2104
LOS: 2.B.2.x
Difficulty: easy
Bloom Code: 1
This method of stock valuation uses the multiples of comparable peers to determine the stock price.
Dividend discount model
Your Answer
Discounted cash flow
Ratio analysis
Correct
Relative valuation
Rationale
 Dividend discount model
This answer is incorrect. The dividend discount model (DDM) is a stock valuation method that determines the stock's price based on the sum of its
future dividend payments, discounted back to present value.
Rationale
 Discounted cash flow
This answer is incorrect. Discounted cash flow (DCF) is a stock valuation method that determines a stock's value based on the investment's future
net cash inflows discounted back to its present value.
Rationale
 Ratio analysis
This answer is incorrect. Ratio analysis is not a stock valuation method but a quantitative method of understanding a company's financial position
and/or performance.
Rationale
 Relative valuation
This answer is correct. Relative valuation is a stock valuation method that uses multiples of similar companies. It associates the stock price to the
comparable peers' multiples and the projected earnings or book value of the company under study for it to determine the stock price.
Question 10
2.B.1.e
tb.types.risk.001_1805
LOS: 2.B.1.e
Difficulty: easy
Bloom Code: 2
Which of the following represents a plot of the relation between expected return and systemic risk?
The beta coefficient
Your Answer
The covariance of returns line

Correct
The security market line
The variance
Rationale
 The beta coefficient
Incorrect. The beta coefficient measures the relation between the risk of an asset and that of the market.
Rationale
 The covariance of returns line
Incorrect. The covariance of returns line describes how the returns of two assets vary against each other over time.
Rationale
 The security market line
Correct. The security market line represents a plot of the relation between expected return and systematic risk.
Rationale
 The variance
Incorrect. The variance measures how much an asset's return varies or changes over time.
Question 11
2.B.3.i
tb.div.pol.sr.003_1805
LOS: 2.B.3.i
Lesson Reference: Dividend Policy and Share Repurchases
Difficulty: easy
Bloom Code: 2
Doorstep Co. stock is currently trading at $25.70 per share. The company pays a regular cash dividend of $0.40 every quarter. Tomorrow is the ex-
dividend date for the upcoming regular dividend. Assuming there is no new information released about the company, how much do you expect the
company's stock to trade for tomorrow? Assume there are no taxes involved.
$0.40
Your Answer
$26.10
Correct
$25.30
$25.70
Rationale
 $0.40
Incorrect. The stock price would not drop this much. The stock is more valuable to investors than just the amount of the dividend.
Rationale
 $26.10
Incorrect. Investors purchasing the stock on or after the ex-dividend date are not entitled to the dividend. Therefore, the stock is less valuable to
investors on or after the ex-dividend date, so the stock price would not increase. This answer incorrectly adds the dividend amount, rather than
subtracting it. The answer is calculated as $25.70 + $0.40 = $26.10.
Rationale
 $25.30
Correct. Investors purchasing the stock on or after the ex-dividend date are not entitled to the dividend. Therefore, the stock is $0.40 less valuable
to investors on or after the ex-dividend date. The answer is calculated as $25.70 − $0.40 = $25.30.
Rationale
 $25.70
Incorrect. Investors purchasing the stock on or after the ex-dividend date are not entitled to the dividend. Therefore, the stock would not have the
same value to investors before and after the ex-dividend date.
Question 12
2.B.3.l
aq.fin.mr.0005_1710
LOS: 2.B.3.l
Lesson Reference: Financial Markets and Regulation
Difficulty: easy
Bloom Code: 1
When corporate insiders buy and sell securities of their own firm, they must report their trades to the:
FASB.
Your Answer
PCAOB.
IRS.
Correct
SEC.
Rationale
 FASB.
The FASB oversees financial accounting standards.
Rationale
 PCAOB.
The PCAOB oversees the audits of public companies.
Rationale
 IRS.
The IRS requires reporting of all stock trades, not just trades made by corporate insiders.
Rationale
 SEC.
Corporate insiders must report their stock trades involving their own firm to the Securities & Exchange Commission.
Question 13
2.B.3.h
aq.div.pol.sr.0005_1710
LOS: 2.B.3.h
Difficulty: easy
Bloom Code: 1
Which type of dividend is typically issued/paid in arrears?
Cash dividend for common stockholders
Stock dividend for common stockholders

Your Answer
Stock split for common stockholders

Correct
Cash dividend for preferred stockholders
Rationale
 Cash dividend for common stockholders
Cash dividends for common stockholders are not paid in arrears.
Rationale
 Stock dividend for common stockholders
Stock dividends for common stockholders are not issued in arrears.
Rationale
 Stock split for common stockholders
Stock splits for common stockholders are not issued in arrears.
Rationale
 Cash dividend for preferred stockholders
Cash dividends for preferred stockholders are typically paid in arrears.
Question 14
2.B.3.d
fin.inst.011_2104
LOS: 2.B.3.d
Lesson Reference: Financial Institutions
Difficulty: hard
Bloom Code: 6
An investment bank has limited resources and can only accommodate one initial public offering (IPO) in a month. Two offers came into its table, namely:
Company A, who wants an underwriting agreement with an underwriting spread of $0.05/share for 100,000 shares, and Company B, who wants a best-
effort sale with 0.5% commission with an offer price per share of $100 for 100,000 shares but expects only 95% of this will be taken. Assuming no
regulatory restrictions are in place, which IPO should the investment bank undertake?
Correct
Company A
Company B
Your Answer
Either; both offers give the same revenue.
Neither; both offers are non-revenue-generating.
Rationale
 Company A
This answer is correct. The revenue from Company A's offer is $0.05 × 100,000 shares = $5,000, while the revenue from Company B's offer is $100 ×
100,000 shares × 0.05% commission × 95% sold = $4,750. Company A's offer gives more revenue than Company B's.
Rationale
 Company B
This answer is incorrect. The revenue from Company A's offer is $0.05 × 100,000 shares = $5,000, while the revenue from Company B's offer is $100
× 100,000 shares × 0.05% commission × 95% sold = $4,750. Company B's offer gives less revenue than Company A's.
Rationale
 Either; both offers give the same revenue.
This answer is incorrect. The revenue from Company A's offer is $0.05 × 100,000 shares = $5,000, while the revenue from Company B's offer is $100
× 100,000 shares × 0.05% commission × 95% sold = $4,750. Company A's offer gives more revenue than Company B's.
Rationale
 Neither; both offers are non-revenue-generating.
This answer is incorrect. Both offers are revenue-generating, and one is better than the other.
Question 15
2.B.5.a
aq.mer.acq.0001_1710
LOS: 2.B.5.a
Lesson Reference: Mergers and Acquisitions
Difficulty: easy
Bloom Code: 2
An acquisition takes places when a firm:
combines with another firm to create a new firm.
Your Answer
buys another firm using debt to finance a significant portion of the transaction.
Correct
buys a controlling interest in another firm.
buys any percentage of ownership in another firm.
Rationale
 combines with another firm to create a new firm.
A merger takes places when two firms combine into one.
Rationale
 buys another firm using debt to finance a significant portion of the transaction.
A leveraged buyout is a merger where the buyer uses debt to finance a significant portion of the transaction.
Rationale
 buys a controlling interest in another firm.
An acquisition is when one firm buys a controlling interest, which is greater than 50% ownership, in another firm.
Rationale
 buys any percentage of ownership in another firm.
To qualify as an acquisition, a firm must buy a controlling interest in another firm.
Question 16
2.B.3.h
LOS: 2.B.3.h
Difficulty: easy
Bloom Code: 2
You own 1,200 shares of Harry Co. The company has recently announced a 1-for-3 reverse stock split. How many shares will you own after the reverse
split?
300 shares
Correct
400 shares
3,600 shares
4,800 shares
Rationale
 300 shares
Incorrect. With a 1-for-3 reverse split, after the split you would not own ¼ the number of shares you owned before the split. The number of shares
is incorrectly calculated as 1,200 ÷ 4.
Rationale
 400 shares
Correct. With a 1-for-3 reverse split, after the split you would own ⅓ the number of shares you owned before the split. The number of shares is
calculated as 1,200 ÷ 3.
Rationale
 3,600 shares
Incorrect. With a 1-for-3 reverse split, after the split you would now own 3 times the number of shares you owned before the split. The number of
shares is incorrectly calculated as 1,200 × 3.
Rationale
 4,800 shares
Incorrect. With a 1-for-3 reverse split, after the split you would not own 4 times the number of shares you owned before the split. The number of
shares is incorrectly calculated as 1,200 × 4.
Question 17
2.B.1.b
aq.types.risk.0002_1710
LOS: 2.B.1.b
Difficulty: easy
Bloom Code: 1
Risk that arises from high-level economic cycles and political environments is referred to as:
Your Answer
unsystematic risk.
Correct
systematic risk.
company risk.
industry risk.
Rationale
 unsystematic risk.
Unsystematic risk refers to the risk an investor assumes from owning stock in one particular company.
Rationale
 systematic risk.
Systematic risk is the risk that arises from high-level economic cycles and political environments.
Rationale
 company risk.
Company risk is another name for unsystematic risk.
Rationale
 industry risk.
Industry risk is the risk associated with a specific industry.
Question 18
2.B.1.h
LOS: 2.B.1.h
Difficulty: hard
Bloom Code: 6
An investor requires an 11% rate of return for all new investments and has the option to invest in two stocks: Company A that has an equity risk premium
of 6% and a beta of 0.8, and/or Company B that has an equity risk premium of 9% and a beta of 1.2. The current risk-free rate is 4%. All of the following
statements are correct except:
The investor should not invest in Company A because its rate of return is 10%.
Correct
The investor should not invest in Company A because its rate of return is 8.8%.
Your Answer
The investor should invest in Company B because it has a 13% rate of return.
The market rate of return is 11.5%.
Rationale
 The investor should not invest in Company A because its rate of return is 10%.
This answer is incorrect. This statement is true. The rate of return can be computed by adding the risk-free rate and equity risk premium. In
Company A’s case, rate of return = 4% + 6% = 10%.
Rationale
 The investor should not invest in Company A because its rate of return is 8.8%.
This answer is correct. This statement is false. This answer is computed as 6% × 0.8 + 4% = 8.8%, which erroneously considered the given equity risk
premium as the market risk premium.
Rationale
 The investor should invest in Company B because it has a 13% rate of return.
This answer is incorrect. This statement is true. The rate of return can be computed by adding the risk-free rate and equity risk premium. In
Company B’s case, rate of return = 4% + 9% = 13%.
Rationale
 The market rate of return is 11.5%.
This answer is incorrect. This statement is true. The market rate of return can be derived by using the given information. Using Company A as an
example, dividing the equity risk premium of 6% by the beta 0.8 will give the market risk premium of 7.5%. To get the market rate of return, we need
to add back the risk-free rate of 4%, bringing us to 11.5%.
Question 19
2.B.3.a
tb.fin.mr.005_1805
LOS: 2.B.3.a
Difficulty: easy
Bloom Code: 2
Why is the term “money market” used?
Your Answer
Firms that issue securities in this market are in dire need of cash.
It is a market where stocks are converted into money.

Correct
The instruments traded in this market are close substitutes for cash.
Investors use money to purchase the securities.
Rationale
 Firms that issue securities in this market are in dire need of cash.
Incorrect. Generally, companies that participate in the money market have a high credit rating and short-term or seasonal needs for cash.
Rationale
 It is a market where stocks are converted into money.
Incorrect. Stocks and other equity securities are not traded on the money market.
Rationale
 The instruments traded in this market are close substitutes for cash.
Correct. Securities with a short maturity and issued by firms with a good credit rating are close substitutes for cash.
Rationale
 Investors use money to purchase the securities.
Incorrect. Investors would use money to purchase any type of security, not just securities issued in the money market.
Question 20
2.B.1.h
tb.cap.ass.005_1805
LOS: 2.B.1.h
Difficulty: medium
Bloom Code: 3
If the market risk premium is currently 6% and the risk-free rate of return is 4%, then what is the expected return on a common share with a beta equal to
2?
8.0%
10.0%
Your Answer
12.0%
Correct
16.0%
Rationale
 8.0%
Incorrect. The market risk premium is not added to the beta to find the expected return. This answer is incorrectly calculated as 6 + 2 = 8.
Rationale
 10.0%
Incorrect. The market risk premium is not added to the risk-free rate of return to find the expected return. This answer is incorrectly calculated as 6
+ 4 = 10.
Rationale
 12.0%
Incorrect. The expected return is not the market risk premium multiplied by the beta. This answer is incorrectly calculated as 6 × 2 = 12.
Rationale
 16.0%
Correct. Using the capital asset pricing model, the expected return = risk free rate + beta * market premium, or .04 + 2 × .06 = .04 + .12 = .16.
Question 21
2.D.1.a
LOS: 2.D.1.a
Difficulty: medium
Bloom Code: 3
A company based in the United States with U.S. dollar as its functional currency decided to take a euro-denominated loan worth €10,000, which will be
payable at the end of the year. The exchange rate when the company borrowed was $1 to €0.92. At the time of payment, it became $1 to €0.83. How much
gain/loss should the company recognize in relation to the loan?
Correct
$1,179 loss
Your Answer
$900 loss
$900 gain
$1,084 loss
Rationale
 $1,179 loss
$1 $1
This answer is correct. The computation is (€10,000 × €
)−( 10,000 × )= 1,179 loss.
€0.83 €0.92
Rationale
 $900 loss
This answer is incorrect. The computation done was (0.83 − 0.92) × €10,000 = 900 loss. This is not the correct way to solve this question because the
$1 $1
computation is in euros. The computation should be (€10,000 × €
)−( 10,000 × )= 1,179 loss.
€0.83 €0.92
Rationale
 $900 gain
This answer is incorrect. The computation done was (0.92 − 0.83) × €10,000 = 900 loss. This is not the correct way to solve this question because the
computation is in euros, and the impact of currency change was interchanged. The computation should be
$1 $1
€
( 10,000 × €
)−( 10,000 × )= 1,179 loss.
€0.83 €0.92
Rationale
 $1,084 loss
$1
This answer is incorrect. The computation done was (0.92 − 0.83)×€10,000 × = 1,084 loss. This is not the correct way to solve this question
€0.83
because even though the loss was converted into the dollar, the conversion was only done at the end of the year. The comparison should be in U.S.
$1 $1
dollar value from one point to another. Thus, the correct equation is: (€10,000 × €
)−( 10,000 × )= 1,179 loss.
€0.83 €0.92
Question 22
2.B.1.h
aq.coc.0005_0720
LOS: 2.B.1.h
Difficulty: medium
Bloom Code: 3
If the Fed caused the risk-free rate to increase, we would expect the cost of capital to:
decrease.
Your Answer
remain unchanged.
Need more information to answer question.

Correct
increase.
Rationale
 decrease.
The Fed would need to decrease the risk-free rate to decrease the cost of capital.
Rationale
 remain unchanged.
A change in the risk-free rate changes the cost of capital.
Rationale
 Need more information to answer question.
Enough information is provided.
Rationale
 increase.
An increase in the risk-free rate will cause the cost of equity to increase using the CAPM (capital asset pricing model) approach. It would also most
likely cause the cost of raising new debt to increase as market rates increase based on the increase in the Fed Funds rate.
Question 23
2.B.3.d
tb.fin.inst.001_1711
LOS: 2.B.3.d
Difficulty: easy
Bloom Code: 1
What is a commercial bank?
Correct
A bank that offers financial services such as checking accounts, savings accounts, lines of credit, and term-loans
A bank that specializes in helping companies sell new debt and equity in the primary markets
Your Answer
A bank that specializes in the sale of derivative instruments
A bank that helps advertising agencies fund the creation of commercials
Rationale
 A bank that offers financial services such as checking accounts, savings accounts, lines of credit, and term-loans
This is the definition of a commercial bank.
Rationale
 A bank that specializes in helping companies sell new debt and equity in the primary markets
This is the definition of an investment bank.
Rationale
 A bank that specializes in the sale of derivative instruments
This is not the definition of a commercial bank.
Rationale
 A bank that helps advertising agencies fund the creation of commercials
This is not the definition of a commercial bank. Good guess though!
Question 24
2.B.3.i
LOS: 2.B.3.i
Difficulty: easy
Bloom Code: 2
Which of the following would be a reason for a board of directors to issue a stock dividend?
Correct
To reduce the stock's market price
To increase income for the stockholders

Your Answer
To decrease the sale of the stock to new stockholders
Because the company wants to decrease its permanent capital
Rationale
 To reduce the stock's market price
A board of directors would declare a stock dividend if they wanted to reduce the stock's market price. A stock dividend would show that the
company was doing well without distributing taxable income to the stockholders. A stock dividend would also increase the company's permanent
capital by transferring amounts from retained earnings to contributed capital.
Rationale
 To increase income for the stockholders
A stock dividend does not provide income; it simply increases the shares outstanding and lowers the stock market price.
Rationale
 To decrease the sale of the stock to new stockholders
A stock dividend does not change the sale of the stock to new stockholders.
Rationale
 Because the company wants to decrease its permanent capital
A stock dividend increases a firm's permanent capital.
Question 25
2.B.5.a
2D6-CQ16
LOS: 2.B.5.a
Difficulty: medium
Bloom Code: 4
Mikey Corporation takes control over Pauley Corporation on July 1. The book value and fair value of Pauley's accounts on that date (prior to creating the
combination) follow, along with the book value of Mikey's accounts (negative numbers show credit balances):
Mikey Book Values Pauley Book Values Pauley Fair Values

Revenue $ 391,000 $ 203,400
Expenses 266,000 125,200
Retained earnings (1/1) 203,000 234,800
Cash and receivables 219,000 93,900 $ 93,900
Inventory 297,000 227,000 273,000
Patented technology (net) 360,000 281,700 313,000
Land 630,000 313,000 352,000
Building and equipment (net) 156,500 117,500 117,500
Liabilities 845,100 563,400 548,000
Common stock 469,500 109,550
Additional paid-in capital 15,700 47,000
Assume that Mikey issues 15,000 shares of common stock with a $10 par value and a $45 fair value to obtain all of Pauley's outstanding stock. How much
goodwill should be recognized?
$205,300
Your Answer
No goodwill
$675,000
Correct
$73,600
Rationale
 $205,300
This answer is incorrect. This answer represents the fair value in excess of book value. However, some of the fair value in excess of book value will
be allocated to specific accounts.
Rationale
 No goodwill
This answer is incorrect. There will be goodwill recognized as a result of this merger.
Rationale
 $675,000
This answer is incorrect. This answer represents consideration transferred, not goodwill. First, book value of subsidiary must be subtracted from
consideration. Then excess fair value must be allocated to specific accounts, leaving goodwill.
Rationale
 $73,600
Goodwill is the excess of consideration given over fair value received. The following table outlines the computation of goodwill for this problem:
Consideration transferred (fair value) $ 675,000

Book value of subsidiary (assets minus liabilities) 469,700
Fair value in excess $ 205,300
Allocation of excess fair over book value Identifies with specific accounts:
Inventory $ 46,000
Patented Technology 31,300
Land 39,000
Long-term liabilities 15,400
Goodwill $ 73, 600
Question 26
2.B.1.h
LOS: 2.B.1.h
Difficulty: hard
Bloom Code: 6
An investor has an opportunity to invest in a company that has a beta of 1.2. Currently, the investor's required rate of return is 10%. If market return is
assumed to be 9%, and treasury note yield is 2%, should the investor accept the opportunity?
Correct
Yes, because the expected return of 10.4% is higher than the investor's required rate.
Your Answer
Rationale
 Yes, because the expected return of 10.4% is higher than the investor's required rate.
This answer is correct. Using CAPM, expected rate of return is computed as 2% + 1.2 × (9% − 2%) = 10.4%.
Rationale
 Yes, because the expected return of 10.8% is higher than the investor's required rate.
This answer is incorrect. It ignores the presence of the risk-free rate in the equation. This answer is computed as 1.2 × 9% = 10.8%.
Rationale
This answer is incorrect. This answer does not follow the CAPM formula but rather is computed as 1.2 × 2% + 9% = 11.4%.
Rationale
This answer is incorrect. This fails to deduct the risk-free rate first to determine the equity risk premium. This answer is computed as 1.2 × 9% + 2%
= 12.8%.
Question 27
2.B.5.a
2D6-LS06
LOS: 2.B.5.a
Difficulty: easy
Bloom Code: 2
Of the following statements, which theory best justifies consolidated financial statements?
In form, the companies are one entity.
In form, the companies are separate.

Your Answer
In form, the companies are one entity; in substance they are separate.
Correct
In form, the companies are separate; in substance they are one entity.
Rationale
 In form, the companies are one entity.
This answer is incorrect. The theory, "In form, the companies are one entity" does not best justify consolidated financial statements.
Rationale
 In form, the companies are separate.
This answer is incorrect. The theory, "In form, the companies are separate" does not best justify consolidated financial statements.
Rationale
 In form, the companies are one entity; in substance they are separate.
This answer is incorrect. The theory, "In form, the companies are one entity; in substance they are separate" does not best justify consolidated
financial statements.
Rationale
 In form, the companies are separate; in substance they are one entity.
From a theoretical standpoint, a parent and its subsidiary are, in fact, two separate companies; however, from a financial reporting standpoint the
two companies are combined into one.
Question 28
2.B.1.a
aq.calc.ret.0003_1710
LOS: 2.B.1.a
Difficulty: medium
Bloom Code: 4
Beta, Inc. recently made an investment in a startup company. The initial investment was $100,000. Over the most recent reporting period, Beta, Inc.
received a $10,000 dividend payment. The value of the investment also increased by $10,000. What is the rate of return of Beta's investment (round to 2
decimals)?
9%
Your Answer
10%
18%
Correct
20%
Rationale
 9%
Remember that the rate of return formula is Return = (Capital Appreciation + Income) ÷ Investment. $10,000 ÷ $110,000 = 9% was used to calculate
this answer. Remember that Capital Appreciation and Income should both be included in the numerator and only Investment should be in the
denominator.
Rationale
 10%
this answer. Remember that Capital Appreciation and Income should both be included in the numerator.
Rationale
 18%
this answer. Remember that only Investment should be in the denominator.
Rationale
 20%
The rate of return formula is Return = (Capital Appreciation + Income) ÷ Investment, and is calculated as ($10,000 + $10,000) ÷ $100,000 = 20%.
Question 29
2.B.1.g
2B2-AT02
LOS: 2.B.1.g
Difficulty: medium
Bloom Code: 3
The beta of Wheeling Inc. common stock is greater than 1. This means that:
the Wheeling stock and the market portfolio have the same systematic risk.
Correct
returns for the Wheeling stock vary more widely than market returns.
Your Answer
the Wheeling stock has the same risk as other stocks with the same credit rating.
the unsystematic risk for the Wheeling stock varies more widely than market returns.
Rationale
 the Wheeling stock and the market portfolio have the same systematic risk.
This answer is incorrect. If the beta of Wheeling Inc. common stock is greater than 1, this does not mean that the Wheeling stock and the market
portfolio have the same systematic risk.
Rationale
 returns for the Wheeling stock vary more widely than market returns.
The beta for a common stock is the ratio of the variability in its returns to the variability in the overall stock market. A common stock with a beta of 1
tracks the market. A common stock with a beta greater than 1 has returns that are more variable than the overall stock market. A common stock
with a beta less than 1 has returns that are less variable than the overall stock market. Therefore, the returns for the stock of Wheeling, Inc. will vary
more widely than market returns.
Rationale
 the Wheeling stock has the same risk as other stocks with the same credit rating.
This answer is incorrect. If the beta of Wheeling Inc. common stock is greater than 1, this does not mean that the Wheeling stock has the same risk
as other stocks with the same credit rating.
Rationale
 the unsystematic risk for the Wheeling stock varies more widely than market returns.
This answer is incorrect. If the beta of Wheeling Inc. common stock is greater than 1, this does not mean that the Wheeling stock varies more widely
than market returns.
Question 30
2.B.3.i
LOS: 2.B.3.i
Difficulty: easy
Who must approve the payment of dividends?
Chief Executive Officer
Your Answer
Chief Financial Officer
Shareholders
Correct
Board of Directors
Rationale
 Chief Executive Officer
All dividends require the approval from the Board of Directors, not the Chief Executive Officer.
Rationale
 Chief Financial Officer
All dividends require the approval from the Board of Directors, not the Chief Financial Officer.
Rationale
 Shareholders
All dividends require the approval from the Board of Directors, not the Shareholders.
Rationale
 Board of Directors
All dividends require the approval from the Board of Directors.
Question 31
2.B.3.f
2B3-AT15
LOS: 2.B.3.f
Lesson Reference: Initial and Secondary Public Offerings
Difficulty: medium
Bloom Code: 3
Some states have laws that provide preemptive rights for shareholders. A preemptive right is when a company must:
Correct
give existing shareholders the opportunity to maintain their proportionate ownership share in the company when issuing a new public offering.
give dividends to the common shareholders first before giving dividends to the preferred shareholders.
Your Answer
sell shares to existing shareholders equal to their proportionate ownership share in the company when issuing a new public offering.
give existing shareholders stock warrants equal to their proportionate ownership share in the company when issuing a new public offering.
Rationale
 give existing shareholders the opportunity to maintain their proportionate ownership share in the company when issuing a new public
offering.
A preemptive right is when a company must give existing shareholders the opportunity to maintain their proportionate ownership share in the
event of a new stock issuance.
Rationale
 give dividends to the common shareholders first before giving dividends to the preferred shareholders.
This answer is incorrect. A preemptive right is not when a company must give dividends to the common shareholders first before giving dividends
to the preferred shareholders.
Rationale
 sell shares to existing shareholders equal to their proportionate ownership share in the company when issuing a new public offering.
This answer is incorrect. A preemptive right is not when a company must sell shares to existing shareholders equal to their proportionate
ownership share in the company when issuing a new public offering.
Rationale
 give existing shareholders stock warrants equal to their proportionate ownership share in the company when issuing a new public
offering.
This answer is incorrect. A preemptive right is not when a company must give existing shareholders stock warrants equal to their proportionate
ownership share in the company when issuing a new public offering.
Question 32
2.B.3.b
LOS: 2.B.3.b
Difficulty: medium
Bloom Code: 4
All of the following are arguments against the efficient market hypothesis except:
Stock price bubbles
Herding effect
Your Answer
Successful value investors

Correct
Popularity of index funds
Rationale
 Stock price bubbles
This answer is incorrect. This is an argument against the efficient market (EMH) because, according to the hypothesis, bubbles cannot exist as the
market prices will adjust accurately. However, market participants inflate market prices beyond their underlying value by actively buying the stock,
similar to the Internet stock bubble in 2001.
Rationale
 Herding effect
This answer is incorrect. The herding effect is another argument against the EMH. Investors can be irrational and trade stocks without regard for
the information available to them about their underlying value. Herding also can lead to stock price bubbles.
Rationale
 Successful value investors
This answer is incorrect. Value investing is an approach where an investor finds undervalued stocks in the market by creating their fundamental
analysis. This is another argument against the EMH, which states that stocks cannot be undervalued as the market accurately accounts for all
information.
Rationale
 Popularity of index funds
This answer is correct. According to the EMH, it is difficult to beat the market, as all participants have access to the information needed to set prices
accurately. Hence, the growing popularity of index funds that closely follow the returns of the market supports the EMH, because more investors
find it difficult to exceed market performance by active trading and would instead invest in passive investments like index funds.
Question 33
2.B.1.f
LOS: 2.B.1.f
Difficulty: medium
Bloom Code: 3
If the stock price of a publicly traded bank historically falls along with an insurance company's stock price, what does it imply regarding their correlation?
The correlation between the stocks is zero.
The correlation between the stocks is less than zero.

Correct
The correlation between the stocks is more than zero.
The correlation between the stocks is more than one.
Rationale
 The correlation between the stocks is zero.
This answer is incorrect. A zero correlation means there is no linear relationship between the two variables.
Rationale
 The correlation between the stocks is less than zero.
This answer is incorrect. A negative correlation means the two variables move in the opposite direction.
Rationale
 The correlation between the stocks is more than zero.
This answer is correct. A positive correlation means the two variables move in the same direction.
Rationale
 The correlation between the stocks is more than one.
This answer is incorrect. Correlation values range between −1 and 1.
Question 34
2.B.5.c
aq.restruc.c.0001_1710
LOS: 2.B.5.c
Lesson Reference: Restructuring and Combining
Difficulty: easy
Bloom Code: 2
Which of the following is not a type of business divestiture?
Spin-off
Equity carve-out
Your Answer
Split-up
Correct
Merger
Rationale
 Spin-off
A spin-off takes place when a firm forms a new company out of a portion of its current divisions or product lines and is a type of business
divestiture.
Rationale
 Equity carve-out
An equity carve-out is a similar restructuring to a spin-off, but the firm sells only a minority interest in the new firm instead of selling the entire
ownership stake and is a type of business divestiture.
Rationale
 Split-up
A split-up takes one firm and splits it into two separately run firms and is a type of business divestiture.
Rationale
 Merger
A merger takes place when two firms combine into one and is not a type of business divestiture.
Question 35
2.B.5.g
aq.eval.bc.0004_1710
LOS: 2.B.5.g
Difficulty: easy
Bloom Code: 2
When using the discounted cash flow method to evaluate a business combination, what is the appropriate assumption about longevity of the target
firm?
Three to five years
Product's projected useful life
Industry average firm life

Correct
Indefinite life
Rationale
 Three to five years
A firm's income is typically estimated for three to five years using the discounted cash flow method, but the firm is assumed to continue to exist
thereafter.
Rationale
 Product's projected useful life
Unlike a product, a firm is assumed to have an indefinite life.
Rationale
 Industry average firm life
The life of other firms is not considered in this situation.
Rationale
 Indefinite life
Firms are considered to have an indefinite life.
Question 36
2.B.5.g
tb.eval.bc.002_1711
LOS: 2.B.5.g
Difficulty: easy
Bloom Code: 2
Which of the following is not a quantitative factor to consider when evaluating a business combination?
Correct
Strength of the management team
Increased margins from better pricing or lower costs of goods due to quantity discounts
Your Answer
Increased revenue from new products or markets
Increase in return on assets because of decreased duplicate assets
Rationale
 Strength of the management team
This is a qualitative, not quantitative, factor to consider when evaluating a business.
Rationale
 Increased margins from better pricing or lower costs of goods due to quantity discounts
This is a quantitative factor to consider when evaluating a business.
Rationale
 Increased revenue from new products or markets
Rationale
 Increase in return on assets because of decreased duplicate assets
Question 37
2.B.2.x
LOS: 2.B.2.x
Difficulty: medium
Bloom Code: 3
A company belongs to an industry that had an average P/E of 10.0x in the previous year. However, because the industry is booming, investors re-rated
the industry and expect an average forward P/E of 20.0x already. Suppose that the company's EPS is expected to be $30.00 next year from just $15.00 last
year; how much is the company's stock using the forward multiple?
$200.00
Your Answer
$300.00
Correct
$600.00
$150.00
Rationale
 $200.00
This answer is incorrect. The computation done was: 20 × 10, which is not right because it only uses the P/E multiples that were given. This should
not be the case because the earnings of the company should be considered in the valuation.
Rationale
 $300.00
This answer is incorrect. The computation done was: 20 × $15, which uses last year's earnings per share figure. The $30 earnings per share should
be used in the computation because using the forward multiple should use the forward EPS.
Rationale
 $600.00
This answer is correct. The computation is $30 × 20, which uses both the forward multiple of 20.0x and the forward EPS of $30.
Rationale
 $150.00
This answer is incorrect. The computation done was: 10 × $15, which uses previous year figures of 10.0x P/E and $15.0 EPS. The question required
us to use the forward multiple, which would mean to use forward EPS as well.
Question 38
2.B.5.a
cma11.p2.t1.me.0027_0820
LOS: 2.B.5.a
Difficulty: medium
Bloom Code: 3
A publicly traded company is planning to divest its Division A for $100 million. Private investors have pooled their capital of $10 million and plan to
finance the balance of $90 million via debt financing with Division A's assets as collateral. The new owners plan to give the new management a bigger
stake in the company by providing stock options. They also redesigned performance measures and incentive schemes for employees to minimize
inefficiencies and bureaucracy. This scenario most closely describes a
*Source: Retired ICMA CMA Exam Questions.
management recapitalization.
Your Answer
management buyout.
leveraged recapitalization.
Correct
leveraged buyout.
Rationale
 management recapitalization.
This answer is incorrect. A management recapitalization is a transaction resulting in a large change to a firm's capital structure. A large amount of
equity is replaced with debt or debt is replaced with equity. It does not involve a change in ownership.
Rationale
 management buyout.
This answer is incorrect. A management buyout is a transaction in which a firm's management team buys a large percentage of the stock of the
company either from the parent company or from private owners. Often a large amount of debt is used to finance the acquisition. In this example,
management is not the purchaser.
Rationale
 leveraged recapitalization.
This answer is incorrect. A leveraged recapitalization is a transaction in which firms borrow a large amount of money and plan to use the borrowed
money to pay a large dividend or to buy back stock. It is not used as part of a divestment.
Rationale
 leveraged buyout.
A leveraged buyout (LBO) is a financing technique where a company is purchased using very little equity. The majority of the financing is in the form
of debt. The firm's assets typically serve as collateral for the debt in an LBO. After an LBO, managers own a larger share of the company, either
directly through stock or indirectly through stock options, than before the transaction.
Question 39
2.B.3.d
aq.fin.inst.0003_1710
LOS: 2.B.3.d
Difficulty: easy
Bloom Code: 1
Banks whose specialty is helping companies sell new debt and equity in the primary markets are called:
Correct
investment banks.
credit unions.
Your Answer
commercial banks.
savings and loan banks.
Rationale
 investment banks.
Banks whose specialty is helping companies sell new debt and equity in the primary markets are called investment banks.
Rationale
 credit unions.
Credit unions are member-owned financial institutions that offer financial services such as checking accounts, savings accounts, lines of credit, and
term-loans.
Rationale
 commercial banks.
Commercial banks offer financial services such as checking accounts, savings accounts, lines of credit, and term-loans.
Rationale
 savings and loan banks.
This is a generic term.
Question 40
2.B.3.k
LOS: 2.B.3.k
Difficulty: medium
Bloom Code: 3
You purchased 3,000 shares of Purple Stuff Beverage Co. four years ago at $30 per share. You have just received a mailing from the company announcing
a fixed-price tender offer stock repurchase at $36 per share. Capital gains are taxed at 15%. If you participate in the repurchase, what is the amount of
after-tax proceeds you will receive?
$18,000
Correct
$105,300
$90,000
$108,000
Rationale
 $18,000
Incorrect. This is the amount of the capital gain, not the amount of after-tax proceeds you will receive. This number is calculated as ($36 − $30) ×
3,000 shares = $18,000.
Rationale
 $105,300
Correct. The tender offer is for 3,000 shares × $36 = $108,000. The cost of the securities is 3,000 shares × $30 = $90,000. The capital gain is $108,000 −
$90,000 = $18,000, and the tax on the capital gain is $18,000 × 15% = $2,700. You will receive $108,000 for the tender offer but pay $2,700 in capital
gains taxes, so you will net $105,300 after tax.
Rationale
 $90,000
Incorrect. This is your cost of the securities, not the amount of after-tax proceeds you will receive. This number is calculated as $30 × 3,000 shares =
$90,000.
Rationale
 $108,000
Incorrect. This is the amount you will receive for the tender offer pre-tax, not the amount of after-tax proceeds you will receive. This number is
calculated as $36 × 3,000 shares = $90,000.
Question 41
2.B.3.h
LOS: 2.B.3.h
Difficulty: medium
Bloom Code: 3
You own 3,000 shares of Split-Holdings Co. The shares are currently selling for $48. The company has just announced a 4-for-1 stock split. How many
shares will you own after the split, and approximately what will your holdings in Split-Holdings Co. be worth?
Correct
12,000 shares worth about $144,000

Your Answer
Rationale
 12,000 shares worth about $144,000
Correct. After a 4-for-1 split, you would own 3,000 × 4 = 12,000 shares. The market value of your holdings will not change from before to after the
split. Before the split, your shares were worth 3,000 × $48 = $144,000. After the split, your shares are worth 12,000 × ($48 ÷ 4) = 12,000 × $12 =
$144,000.
Rationale
 12,000 shares worth about $576,000
Incorrect. The market value of your holdings will not quadruple after a 4:1 split. The number of shares is properly calculated as 3,000 × 4 = 12,000
shares. The value is incorrectly calculated as $144,000 × 4 = $576,000.
Rationale
Incorrect. You will not have 5 times your original share amount after a 4-for-1 split. The number of shares is incorrectly calculated as 3,000 × 5 =
15,000 shares.
Rationale
Incorrect. You will not have 5 times your original share amount and 5 times the original market value of your holdings after a 4-for-1 split. The
number of shares is incorrectly calculated as 3,000 × 5 = 15,000 shares. The value is incorrectly calculated as $144,000 × 5 = $720,000.
Question 42
2.B.3.d
fin.inst.010_2104
LOS: 2.B.3.d
Difficulty: medium
Bloom Code: 4
What is the difference between a best-effort sale and an underwriting agreement between the investment bank and the firm?
An underwriting agreement involves the investment bank giving its highest effort to sell as much as possible of the securities and getting a commission
on the transaction's full value, while a best-effort sale involves the investment bank buying the security from the firm and selling it to the investors.
Correct
An underwriting agreement involves the investment bank buying the firm's security and selling it to the investors, while a best-effort sale involves the
investment bank giving its highest effort to sell as much as possible of the securities and getting a commission on the full transaction.
A best-effort sale involves the investment bank buying the firm's security and doing its best in selling to the investors, while an underwriting agreement
involves the investment bank representing the issuing firm to the investors in selling the securities.
None, the terms can be used interchangeably.
Rationale
 An underwriting agreement involves the investment bank giving its highest effort to sell as much as possible of the securities and getting a
commission on the transaction's full value, while a best-effort sale involves the investment bank buying the security from the firm and selling
it to the investors.
This answer is incorrect. This statement interchanges the two terms being defined.
Rationale
 An underwriting agreement involves the investment bank buying the firm's security and selling it to the investors, while a best-effort sale
involves the investment bank giving its highest effort to sell as much as possible of the securities and getting a commission on the full
transaction.
This answer is correct.
Rationale
 A best-effort sale involves the investment bank buying the firm's security and doing its best in selling to the investors, while an
underwriting agreement involves the investment bank representing the issuing firm to the investors in selling the securities.
This answer is incorrect. This statement does not correctly state the difference between the two.
Rationale
 None, the terms can be used interchangeably.
This answer is incorrect. There is a difference between the two terms.
Question 43
2.B.3.a
aq.fin.mr.0004_1710
LOS: 2.B.3.a
Difficulty: easy
Bloom Code: 1
A market specialist who facilitates exchange between buyers and sellers is called a(n):
dealer.
market-maker.
Your Answer
investment banker.
Correct
broker.
Rationale
 dealer.
A dealer is a market specialist who facilitates exchange by buying and selling securities from his or her own holdings.
Rationale
 market-maker.
A market-maker is a generic term.
Rationale
 investment banker.
An investment banker can take on the role of a broker or a dealer.
Rationale
 broker.
A broker is a market specialist who facilitates exchanges between buyers and sellers. Brokers receive a commission fee as a market matchmaker.
They do not bear any risk of ownership.
Question 44
2.B.3.e
tb.is.ipo.002_1805
LOS: 2.B.3.e
Lesson Reference: Initial and Secondary Public Offerings
Difficulty: medium
Bloom Code: 3
Stump Inc. a technology firm in Prairie View, Texas, issues a $66 million IPO priced at $17 per share, and the offering price to the public is $22 per share.
The firm's legal fees, SEC registration fees, and other administrative costs are $350,000. The firm's stock price increases 15% on the first day. What is the
firm's total cost of issuing the securities?
$9.9 million
Your Answer
$15 million
Correct
$25.25 million
$350,000
Rationale
 $9.9 million
Incorrect. The total cost includes the underpricing cost of 15% of $66 million, or $9.9 million, but also includes other costs of issuing the securities.
Rationale
 $15 million
Incorrect. The total cost includes the spread of ($22 − $17) times 3 million shares ($66 million IPO ÷$22 per share to the public), or $15 million, but
also includes other costs of issuing the securities.
Rationale
 $25.25 million
Correct. The total cost includes the spread of ($22 − $17) times 3 million shares ($66 million IPO ÷$22 per share to the public), or $15 million, plus
the underpricing cost of 15% of $66 million, or $9.9 million, plus the fees and costs of $350,000, for a total cost of $25.25 million.
Rationale
 $350,000
Incorrect. The total cost includes the firm's fees and costs, but also includes other costs of issuing the securities.
Question 45
2.B.5.c
aq.restruc.c.0004_1710
LOS: 2.B.5.c
Lesson Reference: Restructuring and Combining
Difficulty: easy
Bloom Code: 2
Which of the following types of business divestitures is often a result of government concern about monopolistic behavior?
Spin-off
Equity carve-out
Correct
Split-up
Tracking stock
Rationale
 Spin-off
A spin-off takes place when a firm forms a new company out of a portion of its current divisions or product lines and is not usually a result of
government concern about monopolistic behavior.
Rationale
 Equity carve-out
An equity carve-out is a similar restructuring to a spin-off, but the firm sells only a minority interest in the new firm instead of selling the entire
ownership stake and is not usually a result of government concern about monopolistic behavior.
Rationale
 Split-up
A split-up takes one firm and splits it into two separately run firms. A split-up often occurs as a result of government concern about monopolistic
behavior.
Rationale
 Tracking stock
Tracking stocks are ownership shares that are issued by a parent company to monitor the performance of one SBU and are not usually a result of
government concern about monopolistic behavior.
Question 46
2.B.5.b
tb.mer.acq.003_1711
LOS: 2.B.5.b
Difficulty: easy
Bloom Code: 1
Which of the following is a strategy wherein a firm elects only part of its board each year?
Golden parachute
Your Answer
Poison pill
Leveraged recapitulation
Correct
Staggered board of directors
Rationale
 Golden parachute
A golden parachute provides very large payouts to executives released as part of an acquisition.
Rationale
 Poison pill
Poison pills are provisions that make a potential acquisition target less attractive.
Rationale
 Leveraged recapitulation
A leveraged recapitalization makes a firm less attractive to acquiring firms by taking out a significant amount of debt and distributing large cash
dividends to shareholders.
Rationale
 Staggered board of directors
Staggered board of directors is a strategy wherein a firm elects only part of its board each year. By having staggered terms of service on the board
of directors, it makes it more difficult for shareholders to select a majority of board members to vote out current management.
Question 47
2.B.3.b
LOS: 2.B.3.b
Difficulty: hard
Bloom Code: 5
The following statements are likely to occur in an efficient market except:
Merger announcements are reflected in prices immediately.
Insider trading no longer exists.

Correct
Fundamental analysis can reveal undervalued companies.
Market returns outperform actively traded funds.
Rationale
 Merger announcements are reflected in prices immediately.
This answer is incorrect. An efficient market can assimilate new information and reflect its impact on stock prices accurately.
Rationale
 Insider trading no longer exists.
This answer is incorrect. This statement is true for an efficient market since both public and private information is available to all market
participants.
Rationale
 Fundamental analysis can reveal undervalued companies.
This answer is correct. Under the EMH, the market can reflect all available information accurately into pricing. Undervaluation may only exist when
there is information asymmetry among market participants.
Rationale
 Market returns outperform actively traded funds.
This answer is incorrect. Based on the EMH, it is difficult to exceed market returns, as all participants have access to the information they need to set
prices accurately.
Question 48
2.B.3.h
2B3-AT12
LOS: 2.B.3.h
Difficulty: medium
Bloom Code: 4
Arch Inc. has 200,000 shares of common stock outstanding. Net income for the recently ended fiscal year was $500,000, and the stock has a
price/earnings (P/E) ratio of eight. The Board of Directors has just declared a three-for-two stock split. For an investor who owns 100 shares of stock
before the split, the approximate value (rounded to the nearest dollar) of the investment in Arch stock immediately after the split is:
$4,000.
Correct
$2,000.
$1,333.
$3,000.
Rationale
 $4,000.
This answer is incorrect. This answer did not consider that the stock split will not change the value of the firm, nor will it change the value of the
investor's holding.
Rationale
 $2,000.
The stock split will not change the value of the firm, nor will it change the value of the investor's holding.
Original Stock price = (P/E ratio)(EPS)
Where EPS = Earnings Per Share
EPS = Net Income ÷ # share common stock outstanding
EPS = $500,000 ÷ 200,000 = $2.50
Original Stock price = (8)($2.50) = $20
Since the investment value doesn't change with the split, ($20)(100 shares) = $2,000.
After the split, the investor will have 3/2 more shares.
(100 shares)(3/2) = 150 shares
Each share will be worth : $2,000 ÷ 150 shares = $13.33.
Rationale
 $1,333.
This answer is incorrect. This answer did not consider that the investor will now have 150 shares, not 100.
Rationale
 $3,000.
This answer is incorrect. This answer did not consider that the stock split will not change the value of the firm, nor will it change the value of the
investor's holding.
Question 49
2.B.3.j
LOS: 2.B.3.j
Difficulty: medium
Bloom Code: 4
Ray Corp. declared a 5% stock dividend on its 10,000 issued and outstanding shares of $2 par value common stock, which had a fair value of $5 per share
before the stock dividend was declared. This stock dividend was distributed 60 days after the declaration date. By what amount did Ray's current
liabilities increase as a result of the stock dividend declaration?
$500
Correct
$0
Your Answer
$1,000
$2,500
Rationale
 $500
This answer was calculated as the amount of stock dividend share (10,000 × 5%); however, declaration of a stock dividend does not affect current
liabilities as the dividend will not be satisfied with the current assets of the corporation. Rather, shares of stock will be issued to satisfy the
dividend.
Rationale
 $0
Declaration of a stock dividend does not affect current liabilities as the dividend will not be satisfied with the current assets of the corporation.
Rather, shares of stock will be issued to satisfy the dividend. A stock dividend results in a transfer between equity accounts only, the decrease in
retained earnings being offset by an equal increase in the paid-in capital accounts.
Rationale
 $1,000
This answer was calculated as the amount of stock dividend share (10,000 × 5% = 500) × the par value of the common stock ($2); however,
declaration of a stock dividend does not affect current liabilities as the dividend will not be satisfied with the current assets of the corporation.
Rather, shares of stock will be issued to satisfy the dividend.
Rationale
 $2,500
This answer was calculated as the amount of stock dividend shares (10,000 × 5% = 500) × the fair value of the common stock ($5); however,
declaration of a stock dividend does not affect current liabilities as the dividend will not be satisfied with the current assets of the corporation.
Rather, shares of stock will be issued to satisfy the dividend.
Question 50
2.B.3.k
LOS: 2.B.3.k
Difficulty: easy
Bloom Code: 2
Neonia Co. has a policy of returning a minimum of 25% of earnings to shareholders every year through dividend issues and open-market stock
repurchases. In each quarter this year, the company earned $0.25 per share. In each of this year's four quarters, the company paid a regular cash
dividend of $0.05 per share. The company has 2 million shares of common stock outstanding. What amount of stock repurchases could the company's
board approve to meet their target payout percentage?
Open market stock repurchases of $500,000.

Your Answer
No open market stock repurchase is necessary; stockholders have already received 25% of earnings through the quarterly dividend.
Correct
Rationale
 Open market stock repurchases of $500,000.
Incorrect. This amount is 25% of earnings, not the amount of stock repurchases necessary. This answer is calculated as $0.25 × 2 million shares.
Rationale
 Open market stock repurchases of $400,000.
Incorrect. This is the amount of the dividends paid for the year, not the amount of stock repurchases. This answer is calculated as $0.05 × 2 million
shares × 4 quarters.
Rationale
 No open market stock repurchase is necessary; stockholders have already received 25% of earnings through the quarterly dividend.
Incorrect. 25% of the company's earnings is an amount greater than the dividends paid this year, so a stock repurchase is necessary to achieve the
target. 25% of earnings is $0.25 × 2 million shares = $500,000 and dividends paid are $0.05 × 2 million shares × 4 quarters = $400,000.
Rationale
 Open market stock repurchases of $100,000.
Correct. Earnings for the year are $0.25 per share × 4 quarters × 2,000,000 shares = $2,000,000. 25% of this amount is $500,000. Dividends of $0.05 ×
4 quarters × 2,000,000 shares = $400,000. $500,000 − $400,000 leaves $100,000 in necessary stock repurchases.
Question 51
2.B.5.a
2D6-CQ18
LOS: 2.B.5.a
Difficulty: hard
Bloom Code: 4
Vince Company and Cody Enterprises had the following stockholders' equity figures prior to their business combination:
Vince Company Code Enterprises

Common stock ($1 par value) $ 281,700 $ 70,500
Additional paid-in capital $ 140,900 $ 31,300
Retained earnings $ 469,500 $ 172,200
Vince issues 70,000 new shares of its common stock valued at $4 per share for all of the outstanding stock of Cody Enterprises. Assume that Vince
acquires Cody. Immediately after the acquisition, what are the consolidated beginning balances in Additional Paid-in Capital and Retained Earnings
respectfully?
$420,900 and $0
Your Answer
$350,900 and $0
Correct
$350,900 and $469,500
$420,900 and $469,500
Rationale
 $420,900 and $0
This answer is incorrect. When calculating the new balance of additional paid-in capital, this answer did not consider the amount being added to
common stock. Additionally, Vince needs to make no changes to its Retained Earnings, and so the Retained Earnings balance will remain the same
as it was prior to the acquisition.
Rationale
 $350,900 and $0
This answer is incorrect. Vince needs to make no changes to its Retained Earnings, and so the Retained Earnings balance will remain the same as it
was prior to the acquisition.
Rationale
 $350,900 and $469,500
Vince records new shares at fair value

Value of shares issued (70,000 × $4) $ 280,000
Par value of shares issued $ 70,000
Additional paid-in capital (new shares) $ 210,000
Additional paid-in capital (existing shares) $ 140,900
Consolidated additional paid-in capital $ 350,900
Vince needs to make no changes to its Retained Earnings as there were no additions to or subtractions from Retained Earnings at the time of the
acquisition.
Rationale
 $420,900 and $469,500
This answer is incorrect. When calculating the new balance of additional paid-in capital, this answer did not consider the amount being added to
common stock.
Question 52
2.B.1.a
tb.calc.ret.006_1805
LOS: 2.B.1.a
Difficulty: medium
Bloom Code: 3
Which of the following statements is true of amortization?
Correct
With an amortized loan, a bigger proportion of each month's payment goes toward interest in the early periods.
Your Answer
With an amortized loan, a bigger proportion of each month's payment goes toward interest in the later periods.
With an amortized loan, a smaller proportion of each month's payment goes toward interest in the early periods.
With an amortized loan, the interest portion of each month's payment remains unchanged.
Rationale
 With an amortized loan, a bigger proportion of each month's payment goes toward interest in the early periods.
Correct. With a larger principal balance and a fixed payment, a larger proportion of each payment goes toward interest in the early periods.
Rationale
 With an amortized loan, a bigger proportion of each month's payment goes toward interest in the later periods.
Incorrect. With amortization, principal decreases over time while the payment remains the same, so the amount of interest does not increase over
time, so this statement is false.
Rationale
 With an amortized loan, a smaller proportion of each month's payment goes toward interest in the early periods.
Incorrect. With amortization, principal decreases over time while the payment remains the same, so the proportion of interest would not be smaller
in the early periods, so this statement is false.
Rationale
 With an amortized loan, the interest portion of each month's payment remains unchanged.
Incorrect. With amortization, principal decreases over time while the payment remains the same, so the amount of interest would not remain the
same over time, so this statement is false.
Question 53
2.B.3.k
LOS: 2.B.3.k
Difficulty: medium
Bloom Code: 3
You purchased 3,000 shares of Space Apparition Co. four years ago at $40 per share. You have just received a mailing from the company announcing a
fixed-price tender offer stock repurchase at $70 per share. Capital gains are taxed at 20%. If you participate in the repurchase, what is the amount of
after-tax proceeds you will receive?
$90,000
Correct
$192,000
$120,000
$210,000
Rationale
 $90,000
Incorrect. This is the amount of the capital gain, not the amount of after-tax proceeds you will receive. This number is calculated as ($70 − $40) ×
3,000 shares = $90,000.
Rationale
 $192,000
Correct. The tender offer is for 3,000 shares × $70 = $210,000. The cost of the securities is 3,000 shares × $40 = $120,000. The capital gain is $210,000
− $120,000 = $90,000, and the tax on the capital gain is $90,000 × 20% = $18,000. You will receive $210,000 for the tender offer but pay $18,000 in
capital gains taxes, so you will net $192,000 after tax.
Rationale
 $120,000
Incorrect. This is your cost of the securities, not the amount of after-tax proceeds you will receive. This number is calculated as $40 × 3,000 shares =
$120,000.
Rationale
 $210,000
Incorrect. This is the amount you will receive for the tender offer pre-tax, not the amount of after-tax proceeds you will receive. This number is
calculated as $70 × 3,000 shares = $210,000.
Question 54
2.B.3.h
LOS: 2.B.3.h
Difficulty: hard
Bloom Code: 4
Pluto Co. stock is currently trading for $54. Assume there is no new information about the company. If the company issues a 10% stock dividend, what
will the approximate price of the stock be after the stock dividend is issued? (Round your final answer to two decimal places.)
$44.00 per share
$59.40 per share

Correct
$49.09 per share

Your Answer
$54.00 per share
Rationale
 $44.00 per share
Incorrect. After the stock dividend, there is a 10% increase in shares with no increase in market value of the total amount of shares. A stockholder
with 1,000 shares before the stock dividend would have market value of 1,000 × $54 = $54,000. That same stockholder after the stock dividend
would have market value of 1,100 × $44.00 = $48,400.
Rationale
Incorrect. After the stock dividend, there is a 10% increase in shares with no increase in market value of the total amount of shares. A stockholder
with 1,000 shares before the stock dividend would have market value of 1,000 × $54 = $54,000. That same stockholder after the stock dividend
would have market value of 1,100 × $59.40 = $65,340.
Rationale
 $49.09 per share
Correct. After the stock dividend, there is a 10% increase in shares with no increase in market value of the total amount of shares. $54 ÷ 110% =
$49.09. A stockholder with 1,000 shares before the stock dividend would have market value of 1,000 × $54 = $54,000. That same stockholder after
the stock dividend would have market value of 1,100 × $49.09 = $54,000.
Rationale
Incorrect. After the stock dividend, there is a 10% increase in shares with no increase in market value of the total amount of shares. $54 ÷ 110% =
$49.09. A stockholder with 1,000 shares before the stock dividend would have market value of 1,000 × $54 = $54,000. That same stockholder after
the stock dividend would have market value of 1,100 × $54.00 = $59,400.
Question 55
2.B.2.w
LOS: 2.B.2.w
Difficulty: medium
Bloom Code: 3
A company's stock is trading at $20 per share. If the company has a 7% cost of capital and announced that it would distribute $1 dividends per share next
year, what is the dividend growth that investors expect out of the stock?
7%
5%
Your Answer
9%
Correct
2%
Rationale
 7%
This answer is incorrect. The cost of capital is not the same as dividend growth. Note that the formula to get the stock price is: D1 ÷ (r − g); where D1
is the expected dividend per share in the following year, r is the cost of equity, and g is the constant growth rate in perpetuity.
Rationale
 5%
This answer is incorrect. The computation done was $1 ÷ $20 which is the stock's dividend yield next year. The question asks for the dividend
growth rate.
Rationale
 9%
This answer is incorrect. The computation done was 7% + ($1 ÷ $20), which incorrectly adds the yield for next year to the cost of capital while it
should have been subtracted to get the expected dividend growth.
Rationale
 2%
This answer is correct. The computation is: 7% − ($1 ÷ $20). This was a play on the formula of the dividend discount model: Stock price = D1 ÷ (r − g);
where D1 is the expected dividend per share in the following year, r is the cost of equity, and g is the constant growth rate in perpetuity.
Question 56
2.B.1.a
tb.calc.ret.003_1805
LOS: 2.B.1.a
Difficulty: medium
Bloom Code: 3
If the supply of loanable funds decreases relative to the demand for those funds, then we would expect which outcome?
Interest rates to remain unchanged.
Correct
Interest rates to increase.

Your Answer
Interest rates to decrease.
The cost of money to remain unchanged.
Rationale
 Interest rates to remain unchanged.
Incorrect. Interest is the cost of borrowing. When demand for loanable funds rises relative to the supply, the cost of borrowing does not remain
unchanged.
Rationale
 Interest rates to increase.
Correct. Interest is the cost of borrowing. When demand for loanable funds rises relative to the supply, the cost of borrowing will increase.
Rationale
 Interest rates to decrease.
Incorrect. Interest is the cost of borrowing. When demand for loanable funds rises relative to the supply, the cost of borrowing will not decrease.
Rationale
 The cost of money to remain unchanged.
Incorrect. Interest is the cost of borrowing. When demand for loanable funds rises relative to the supply, the cost of borrowing does not remain
unchanged.
Question 57
2.B.3.k
LOS: 2.B.3.k
Difficulty: medium
Bloom Code: 3
Calciya Co. has a policy of returning a minimum of 40% of earnings to shareholders every year through dividend issues and open-market stock
repurchases. In each quarter this year, the company earned $0.20 per share. In each of this year's four quarters, the company paid a regular cash
dividend of $0.05 per share. The company has 8 million shares of common stock outstanding. What amount of stock repurchases could the company's
board approve to meet their target payout percentage?
Open market stock repurchases of $2,560,000.
Open market stock repurchases of $1,600,000.

Your Answer
No open market stock repurchase is necessary, stockholders have already received 40% of earnings through the quarterly dividend.
Correct
Rationale
 Open market stock repurchases of $2,560,000.
Incorrect. This amount is 40% of earnings, not the amount of stock repurchases necessary. This answer is calculated as 40% × $0.20 × 4 quarters × 8
million shares.
Rationale
 Open market stock repurchases of $1,600,000.
Incorrect. This is the amount of the dividends paid for the year, not the amount of stock repurchases. This answer is calculated as $0.05 × 4 quarters
× 8 million shares.
Rationale
 No open market stock repurchase is necessary, stockholders have already received 40% of earnings through the quarterly dividend.
Incorrect. 40% of the company's earnings is an amount greater than the dividends paid this year, so a stock repurchase is necessary to achieve the
target. 40% of earnings is calculated as 40% × $0.20 × 4 quarters × 8 million shares = $2,560,000. Current year dividends are $0.05 × 4 quarters × 8
million shares = $1,600,000. The difference indicates additional distributions to shareholders are needed.
Rationale
 Open market stock repurchases of $960,000.
Correct. Earnings for the year are $0.20 per share × 4 quarters × 8,000,000 shares = $6,400,000. 40% of this amount is $2,560,000. Dividends of $0.05
× 4 quarters × 8,000,000 shares = $1,600,000. $2,560,000 − $1,600,000 leaves $960,000 in necessary stock repurchases.
Question 58
2.B.1.g
2B1-LS08
LOS: 2.B.1.g
Difficulty: easy
Bloom Code: 2
Which of the following best describes a stock with a beta greater than 1.0?
Correct
Returns on the stock will most likely vary more than market returns.
Your Answer
Returns on the stock will move in the same direction as the market but not as far.
The stock incurs the same level of unsystematic risk as stocks with similar credit ratings.
The stock incurs the same level of systemic risk as stocks with similar credit ratings
Rationale
 Returns on the stock will most likely vary more than market returns.
The average beta of all stocks is 1.0. Stocks with a beta greater than 1.0 are unusually sensitive to market movements and amplify overall market
movements.
Rationale
 Returns on the stock will move in the same direction as the market but not as far.
This answer is incorrect. "Returns on the stock will move in the same direction as the market but not as far" does not best describe a stock with a
beta greater than 1.0.
Rationale
 The stock incurs the same level of unsystematic risk as stocks with similar credit ratings.
This answer is incorrect. "The stock incurs the same level of unsystematic risk as stocks with similar credit ratings" does not best describe a stock
with a beta greater than 1.0.
Rationale
 The stock incurs the same level of systemic risk as stocks with similar credit ratings
This answer is incorrect. "The stock incurs the same level of systemic risk as stocks with similar credit ratings" does not best describe a stock with a
beta greater than 1.0.
Question 59
2.B.5.a
2B5-CQ36
LOS: 2.B.5.a
Difficulty: medium
Bloom Code: 4
Company ABC is considering acquiring Company XYZ in a stock-for-stock exchange. Financial data for the two companies are as follows:
ABC Company XYZ Company Combined

Sales (millions) $1,050 $ 113 $1,163
Net income (millions) $53 $14.5 $67.5
Common shares outstanding (millions) 10.5 6.0 ?
Earnings per share (EPS) $9 $4 ?
Common stock price per share $88 $30 $88
Using the comparative P/E ratio method, what would be the maximum combined common shares outstanding required to maintain an EPS of $8.75 in
the new combined organization?
Correct
7,714,286
1,657,143
Your Answer
6,057,143
4,400,000
Rationale
 7,714,286
The combined EPS target is determined to be $8.75 per share. To achieve the $8.75 targeted earnings per share, the combined number of common
shares outstanding would have to be no more than 7,714,286 ($67.5 million combined net income divided by the required $8.75 EPS = 7,714,286
shares).
Rationale
 1,657,143
This answer is incorrect. This answer represents the maximum common shares outstanding for XYZ Company, not the new combined organization.
Rationale
 6,057,143
This answer is incorrect. This answer represents the maximum common shares outstanding for ABC Company, not the new combined organization.
Rationale
 4,400,000
This answer is incorrect. This answer incorrectly calculated the maximum common shares outstanding required to maintain an EPS of $8.75 for the
new combined organization. This answer subtracted XYZ Company shares from ABC Company shares instead of adding them.
Question 60
2.B.1.g
tb.cap.ass.001_1805
LOS: 2.B.1.g
Difficulty: easy
Bloom Code: 2
A portfolio with a level of systematic risk that is the same as that of the market has a beta that is which of the following?
Equal to zero
Correct
Equal to one
Your Answer
Less than the beta of the risk-free asset
Less than zero
Rationale
 Equal to zero
Incorrect. A portfolio with a beta of zero would have zero risk.
Rationale
 Equal to one
Correct. A beta of one indicates a level of risk the same as that of the market.
Rationale
 Less than the beta of the risk-free asset
Incorrect. A beta less than the beta of the risk-free asset would mean that the asset has less risk than the risk-free asset.
Rationale
 Less than zero
Incorrect. A portfolio with a beta less than zero would have the opposite systematic risk of the market (for example, when the market increases, the
portfolio would decrease).

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12/29/23, 11:07 AM CMA Exam Review - Part 2 - Assessment Review

Need more information to answer question.

*Source: Retired ICMA CMA Exam Questions.

Expand market share

The value of a business is solely affected by managers’ financing decisions.

Mustang because the coefficient of variation is higher.

Mustang because the return is lower.

Cornhusker because the coefficient of variation is lower.

Coefficient of variation = σ/¯R̄

Coefficient of variation for Mustang = 0.09 / 0.1 = 0.9

Coefficient of variation for Cornhusker = 0.15 / 0.2 = 0.75

based on the number of securities in the portfolio.

in direct proportion to beta in a competitive environment.

in direct proportion to the prime interest rate.

Interest rate risk

Discounted cash flow

The covariance of returns line

The security market line

Stock dividend for common stockholders

Stock split for common stockholders

Cash dividend for preferred stockholders

Either; both offers give the same revenue.

Neither; both offers are non-revenue-generating.

buys a controlling interest in another firm.

buys any percentage of ownership in another firm.

The market rate of return is 11.5%.

It is a market where stocks are converted into money.

Investors use money to purchase the securities.

Need more information to answer question.

A bank that specializes in the sale of derivative instruments

A bank that helps advertising agencies fund the creation of commercials

To reduce the stock's market price

To increase income for the stockholders

To decrease the sale of the stock to new stockholders

Because the company wants to decrease its permanent capital

Mikey Book Values Pauley Book Values Pauley Fair Values

Consideration transferred (fair value) $ 675,000

In form, the companies are separate.

Chief Financial Officer

Successful value investors

Popularity of index funds

The correlation between the stocks is less than zero.

The correlation between the stocks is more than zero.

The correlation between the stocks is more than one.

Product's projected useful life

Industry average firm life

Strength of the management team

Increased revenue from new products or markets

Increase in return on assets because of decreased duplicate assets

*Source: Retired ICMA CMA Exam Questions.

savings and loan banks.

12,000 shares worth about $144,000

12,000 shares worth about $576,000

15,000 shares worth about $144,000

15,000 shares worth about $720,000

None, the terms can be used interchangeably.

Staggered board of directors

Insider trading no longer exists.

Fundamental analysis can reveal undervalued companies.

Market returns outperform actively traded funds.

Original Stock price = (P/E ratio)(EPS)

Where EPS = Earnings Per Share

EPS = Net Income ÷ # share common stock outstanding

EPS = $500,000 ÷ 200,000 = $2.50