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1) Which of the following statements is INCORRECT? A) In general, money today is worth more than money in one year

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1) Which of the following statements is INCORRECT?

A) In general, money today is worth more than money in one year.

B) We define the risk-free interest rate, rf for a given period as the interest rate at which money can be borrowed or lent without risk over that period.

C) We refer to (1 - rf) as the interest rate factor for risk-free cash flows.

D) For most financial decisions, costs and benefits occur at different points in time.

 

2)Which of the following statements regarding arbitrage is the most correct?

A) Any situation in which it is possible to make a profit without taking any risk is known as an arbitrage opportunity.

B) Any situation in which it is possible to make a profit without making any investment is known as an arbitrage opportunity.

C) We call a competitive market in which there are no arbitrage opportunities an arbitrage market.

D) The practice of buying and selling equivalent goods in different markets to take advantage of a price difference is known as arbitrage.

 

3)Which of the following statements regarding the Law of One Price is INCORRECT?

A) At any point in time, the price of two equivalent goods trading in different competitive markets will be the same.

B) One useful consequence of the Law of One Price is that when evaluating costs and benefits to compute a net present value, we can use any competitive price to determine a cash value, without checking the price in all possible markets.

C) If equivalent goods or securities trade simultaneously in different competitive markets, then they will trade for the same price in both markets.

D) An important property of the Law of One Price is that it holds even in markets where arbitrage is not possible.

 

4)Which of the following statements regarding arbitrage and security prices is INCORRECT?

A) We call the price of a security in a normal market the no-arbitrage price for the security.

B) In financial markets it is possible to sell a security you do not own by doing a short sale.

C) When a bond is underpriced, the arbitrage strategy involves selling the bond and investing some of the proceeds.

D) The general formula for the no-arbitrage price of a security is Price(security) = PV(All cash flows paid by the security).

 

5) Consider two securities, A & B.  Suppose a third security, C, has the same cash flows as A and B combined.  Given this information about securities A,B, & C, which of the following statements is INCORRECT?

A) If the total price of A and B is cheaper than the price of C, then we could make a profit selling A and B and buying C.

B) Price(C) = Price(A) + Price(B)

C) Because security C is equivalent to the portfolio of A and B, by the law of one price they must have the same price.

D) The relationship known as value additivity says that the value of a portfolio is equal to the sum of the values of its parts.

 

6) Which of the following statements regarding value additivity is FALSE?

A) The value of a portfolio is equal to the sum of the values of its parts.

B) The price or value of the entire firm is equal to the sum of the values of all projects and investments within the firm.

C) To maximize the value of the entire firm, managers should make decisions that maximize NPV.

D) Value additivity does not have important consequences for the value of the entire firm, only on portfolios of firms.

 

7) Which of the following statements is FALSE?

A) Financial transactions are not sources of value, but merely serve to adjust the timing and risk of the cash flows to best suit the needs of the firm or its investors.

B) The NPV of trading a security in a normal market is zero.

C) We cannot separate a firm's investment decision from the decision of how to finance the investment.

D) In normal markets, trading securities neither creates nor destroys value.