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Free Questions › CTP › Capital Structure and Long-Term Financing
Free CTP Capital Structure and Long-Term Financing Practice Questions & Answers
150 exam-style Capital Structure and Long-Term Financing questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 61
An investor buys a call option with a $50 strike for a $3 premium. At expiration the underlying trades at $55. What is the option's intrinsic value and the investor's net profit per share?
Select an option first.
Correct answer: A — Intrinsic value $5; net profit $2
Explanation: Intrinsic value of a call = underlying price - strike = $55 - $50 = $5. Net profit = intrinsic value - premium paid = $5 - $3 = $2 per share. The call is in the money because the underlying exceeds the strike, and the profit is what remains after recovering the premium.
Question 62
The spot exchange rate is $1.10 per euro. The one-year U.S. interest rate is 4% and the one-year euro interest rate is 2%. Using covered interest rate parity, what is the approximate one-year forward rate (USD per euro)?
Select an option first.
Correct answer: C — $1.122
Explanation: Forward = spot x (1 + domestic rate) / (1 + foreign rate) = $1.10 x (1.04 / 1.02) = $1.10 x 1.01961 = $1.1216, about $1.122. Because the U.S. rate exceeds the euro rate, the euro trades at a forward premium against the dollar. Covered interest rate parity prevents riskless arbitrage between the money and forward markets.
Question 63
A company has net income of $12 million and 6 million shares outstanding. It repurchases 1 million shares. Ignoring any financing cost, what is the new earnings per share?
Select an option first.
Correct answer: B — $2.40
Explanation: Before the buyback, EPS = $12 million / 6 million = $2.00. After repurchasing 1 million shares, shares outstanding fall to 5 million, so EPS = $12 million / 5 million = $2.40. Reducing the share count raises EPS when net income is unchanged, one reason firms use buybacks.
Question 64
A company reports net income of $10 million and pays total dividends of $4 million. What is its dividend payout ratio?
Select an option first.
Correct answer: B — 40%
Explanation: Dividend payout ratio = dividends / net income = $4 million / $10 million = 0.40, or 40%. This means 40% of earnings are distributed to shareholders and the remaining 60% (the retention ratio) is reinvested in the business. The payout ratio reflects the firm's balance between returning cash and funding growth.
Question 65
A firm increases its use of financial leverage. Holding operating results constant, what is the most likely effect on the volatility of earnings per share (EPS) and the cost of equity?
Select an option first.
Correct answer: C — Both EPS volatility and the cost of equity increase
Explanation: Higher fixed interest obligations magnify the impact of changes in operating income on net income, increasing the degree of financial leverage and thus EPS volatility. As equity holders bear more risk, they demand a higher return, so the cost of equity rises. This is consistent with MM Proposition II, where the cost of equity increases with the debt-to-equity ratio.
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Question 66
According to the pecking order theory of financing, a profitable firm needing external funds will generally prefer to raise capital in which order?
Select an option first.
Correct answer: B — Internal funds first, then debt, then new equity as a last resort
Explanation: Pecking order theory, based on asymmetric information, holds that managers prefer internally generated funds because they avoid issuance costs and signaling problems. When external funds are needed, safer debt is preferred over equity because issuing equity may signal that management believes shares are overvalued. New equity is therefore a last resort.
Question 67
A borrower's credit agreement caps its total-debt-to-EBITDA ratio at 4.0x. The firm has $360 million of debt and EBITDA of $100 million. If EBITDA falls to $85 million with debt unchanged, what happens?
Select an option first.
Correct answer: B — The firm breaches the covenant because leverage rises to about 4.2x
Explanation: At $85 million EBITDA, leverage = $360 million / $85 million = 4.24x, which exceeds the 4.0x cap and constitutes a covenant breach. Covenants tied to EBITDA can be tripped by falling earnings even when debt is unchanged. A breach may trigger default, higher pricing, or a required waiver from lenders.
Question 68
An accordion feature in a syndicated credit agreement allows the borrower to:
Select an option first.
Correct answer: B — Increase the size of the facility later, subject to lender consent and conditions, without renegotiating the whole agreement
Explanation: An accordion (or incremental facility) provision lets a borrower request an increase to the committed amount after closing, up to a pre-agreed cap, provided conditions are met and lenders (existing or new) agree to fund it. It offers flexibility to expand borrowing capacity without documenting an entirely new facility. It does not obligate lenders to fund automatically.
Question 69
For a callable bond trading at a premium, which relationship generally holds?
Select an option first.
Correct answer: A — Yield to call is typically lower than yield to maturity
Explanation: When a bond trades at a premium, it is often because market rates have fallen, making an early call likely. Because the call shortens the time to receive cash and the call price is usually near par (below the premium market price), the yield to call is generally lower than the yield to maturity. Prudent investors evaluate the yield to worst, the lower of the two.
Question 70
A make-whole call provision differs from a standard fixed-price call because it:
Select an option first.
Correct answer: B — Requires the issuer to pay a redemption price based on the present value of remaining cash flows discounted at a small spread over a benchmark rate
Explanation: A make-whole call sets the redemption price at the greater of par or the present value of remaining coupons and principal, discounted at a reference Treasury yield plus a modest spread. This structure compensates investors for lost future cash flows, making early redemption expensive for the issuer. It is common in investment-grade corporate bonds and is rarely exercised opportunistically.
Question 71
In an IPO, a greenshoe (over-allotment) option allows the underwriters to:
Select an option first.
Correct answer: B — Sell additional shares (typically up to 15% more) if demand is strong, helping stabilize the aftermarket price
Explanation: A greenshoe option lets underwriters sell more shares than originally planned, usually up to 15% of the deal, when demand is high. If the price falls after listing, they can buy shares in the market to cover a short position, supporting the price; if it rises, they exercise the option at the offer price. This mechanism helps stabilize the stock immediately after the IPO.
Question 72
IPO underpricing, where the offer price is set below the price at which the stock first trades, is often explained by:
Select an option first.
Correct answer: B — Information asymmetry and the underwriters' incentive to ensure the deal sells and to reward investors for bearing uncertainty
Explanation: Underpricing leaves 'money on the table' for the issuer but is commonly attributed to information asymmetry between issuers, underwriters, and investors, and to the need to compensate investors for the risk of an unproven security. It also helps guarantee full subscription and rewards institutions that provide honest demand indications during bookbuilding. Persistent first-day pops are a well-documented empirical pattern.
Question 73
When two mutually exclusive projects give conflicting rankings under NPV and IRR, which method should generally be relied upon and why?
Select an option first.
Correct answer: B — NPV, because it measures the dollar value added and assumes reinvestment at the cost of capital
Explanation: NPV is generally preferred for mutually exclusive projects because it directly measures the absolute increase in firm value and assumes intermediate cash flows are reinvested at the cost of capital, a more realistic assumption. IRR can rank projects incorrectly due to differences in scale or timing and its implicit reinvestment at the IRR itself. When the two conflict, choose the project with the higher NPV.
Question 74
Compared with a laddered portfolio, a barbell strategy concentrates holdings in:
Select an option first.
Correct answer: B — Short-term and long-term maturities, with little in the intermediate range
Explanation: A barbell places funds at the two ends of the maturity spectrum, short-term securities for liquidity and long-term securities for higher yield, while underweighting the middle. It offers flexibility to respond to rate changes at the short end while capturing yield at the long end. A ladder, by contrast, distributes maturities evenly across the horizon.
Question 75
A treasury manager expects interest rates to rise. To reduce the portfolio's price sensitivity to that increase, the manager should generally:
Select an option first.
Correct answer: B — Shorten the portfolio's average duration
Explanation: Duration measures a portfolio's price sensitivity to interest-rate changes; longer duration means larger price declines when rates rise. Anticipating rising rates, a manager shortens duration, shifting toward shorter maturities or floating-rate instruments, to limit market-value losses and enable reinvestment at higher rates. Extending duration would increase the loss.
Question 76
In evaluating an acquisition, the maximum price an acquirer should rationally pay for a target is best described as the target's:
Select an option first.
Correct answer: B — Standalone value plus the value of expected synergies
Explanation: The economic ceiling on the offer price is the target's intrinsic standalone value plus the present value of synergies the acquirer expects to create. Paying up to that amount preserves value for the acquirer only if synergies are actually realized; paying more transfers value to target shareholders. Overestimating synergies is a common cause of value-destroying acquisitions.
Question 77
In a leveraged buyout (LBO), the acquiring group typically:
Select an option first.
Correct answer: B — Uses a large proportion of borrowed funds, often secured by the target's assets and repaid from its cash flows
Explanation: An LBO finances the acquisition predominantly with debt, frequently secured against the target's assets and serviced by its operating cash flows. The high leverage amplifies returns to equity if the business performs but increases financial risk and the burden of debt service. Sponsors aim to improve operations and reduce debt over the holding period before exiting.
Question 78
An inverted yield curve, where short-term yields exceed long-term yields, is often interpreted by markets as:
Select an option first.
Correct answer: B — A potential signal of expected economic slowdown or future rate cuts
Explanation: An inverted curve arises when short-term rates are higher than long-term rates, frequently reflecting expectations that the central bank will lower rates amid slowing growth. Historically, inversions have often preceded recessions, making the shape of the curve a watched indicator. For borrowers, an inversion can affect the relative attractiveness of short- versus long-term funding.
Question 79
A treasurer expects to issue long-term bonds in six months and is concerned that benchmark rates may rise before issuance. A common strategy to manage this pre-issuance interest-rate risk is to:
Select an option first.
Correct answer: B — Enter a forward-starting interest-rate hedge, such as a Treasury lock or forward-starting swap, to lock in today's rate level
Explanation: To hedge anticipated issuance against rising rates, a treasurer can use a Treasury lock or a forward-starting swap that fixes the benchmark component of the future coupon at current levels. If rates rise, gains on the hedge offset the higher borrowing cost; if rates fall, the hedge loss offsets the lower cost. This locks in the effective rate and reduces uncertainty about future funding costs.
Question 80
A key difference between exchange-traded futures and over-the-counter forwards is that futures:
Select an option first.
Correct answer: B — Are standardized, marked to market daily, and use a clearinghouse to reduce counterparty risk
Explanation: Futures are standardized contracts traded on an exchange, marked to market daily with margin requirements, and guaranteed by a central clearinghouse that greatly reduces counterparty credit risk. Forwards are customized OTC agreements settled at maturity, exposing each side to the other's default risk. The daily settlement and clearing structure is the defining operational difference.
Question 81
A manufacturer hedges its future purchase of jet fuel using crude oil futures because no liquid jet-fuel contract is available. The residual risk that the price relationship between jet fuel and crude oil may change is called:
Select an option first.
Correct answer: B — Basis risk
Explanation: Using a related but not identical instrument to hedge is a cross hedge, and the risk that the hedged item's price and the hedging instrument's price do not move perfectly together is basis risk. If the jet-fuel-to-crude spread widens or narrows unexpectedly, the hedge will not fully offset the exposure. Basis risk is an inherent trade-off when a perfectly matched derivative is unavailable.
Question 82
Under the Modigliani-Miller dividend irrelevance proposition (in perfect markets), a firm's value is unaffected by its dividend policy because:
Select an option first.
Correct answer: B — Investors can create their own desired cash flows by buying or selling shares (homemade dividends)
Explanation: In frictionless markets, MM argue that dividend policy does not affect firm value because investors indifferent to the timing of cash can replicate any payout pattern themselves by selling shares (homemade dividends) or reinvesting. Value depends on the firm's investment and earning power, not on how returns are split between dividends and capital gains. In practice, taxes, signaling, and transaction costs make dividend policy matter.
Question 83
Which statement best describes a company's weighted average cost of capital (WACC)?
Select an option first.
Correct answer: B — The blended required return on the firm's capital, weighting the cost of each financing source by its proportion of total capital
Explanation: WACC is the average rate a firm expects to pay to finance its assets, weighting the cost of debt and equity by their respective shares of total capital. It uses the after-tax cost of debt and the required return on equity. WACC serves as the standard discount rate for evaluating projects of average risk.
Question 84
Under the trade-off theory of capital structure, the optimal debt level is reached when:
Select an option first.
Correct answer: C — The marginal tax benefit of additional debt equals the marginal cost of financial distress
Explanation: Trade-off theory holds that firms balance the tax advantages of debt against the expected costs of financial distress and bankruptcy. The optimum occurs where the marginal value of the tax shield from one more dollar of debt just offsets the marginal increase in distress costs. Beyond that point additional leverage reduces firm value.
Question 85
Under Modigliani and Miller's Proposition I in a world with no taxes, a firm's total value is:
Select an option first.
Correct answer: B — Independent of its capital structure
Explanation: MM Proposition I (no taxes) states that in perfect markets a firm's value is determined by its operating assets and earning power, not by how it is financed. Changing the debt-to-equity mix merely reallocates risk and return between debt and equity holders. Only when frictions such as taxes and distress costs are introduced does capital structure affect value.
Question 86
In a syndicated loan, the role of the lead arranger (or agent bank) is primarily to:
Select an option first.
Correct answer: B — Structure the loan, recruit participating lenders, and administer the facility
Explanation: The lead arranger structures the terms, negotiates with the borrower, and syndicates portions of the loan to a group of participating lenders. The agent bank then administers payments, monitors covenants, and communicates between the borrower and the syndicate. It does not guarantee the loan or absorb all the credit risk itself.
Question 87
A revolving credit facility differs from a term loan primarily because it:
Select an option first.
Correct answer: B — Allows the borrower to draw, repay, and re-borrow up to a committed limit during the availability period
Explanation: A revolver provides flexible access to funds up to a stated commitment, letting the borrower draw and repay repeatedly as needs fluctuate. This makes it well suited to seasonal or working-capital financing. A term loan, by contrast, is typically disbursed as a lump sum and amortized on a fixed schedule.
Question 88
A loan covenant that requires the borrower to maintain a minimum interest coverage ratio is an example of a:
Select an option first.
Correct answer: B — Financial (maintenance) covenant
Explanation: Financial or maintenance covenants require the borrower to keep specified financial ratios within agreed limits, such as a minimum interest coverage or a maximum leverage ratio. Negative covenants restrict actions like taking on new debt, while affirmative covenants require actions like delivering financial statements. Financial covenants give lenders an early warning of deteriorating credit quality.
Question 89
In a syndicated facility, the administrative agent's ongoing duties typically include:
Select an option first.
Correct answer: B — Collecting and distributing payments and monitoring covenant compliance
Explanation: The administrative agent acts as the operational hub of the syndicate, receiving the borrower's interest and principal payments and passing them to lenders in proportion to their commitments. It also tracks covenant compliance and coordinates amendments or waivers. It is an administrative role, not a guarantor or underwriter.
Question 90
The coupon rate on a bond refers to:
Select an option first.
Correct answer: B — The annual interest paid as a percentage of the bond's face value
Explanation: The coupon rate is the fixed annual interest expressed as a percentage of par (face) value; a 5% coupon on a $1,000 bond pays $50 per year. It is set at issuance and does not change, whereas the bond's yield fluctuates with market price. Coupon and yield are equal only when the bond trades at par.
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