FBE 432 - Midterm ExaminationP R A C T I C E Q U E S T I O N SFBE 432 - Midterm ExaminationP R A C T I C E Q U E S T I O N SPART II - LONGER ANSWERS - WRITE ANSWERS IN SPACE PROVIDED.1. Venture capitalists provide a useful role in an economy, but they expect to earn high rates of return. Discuss the role venture capitalists play with start-up firms in terms of the (a) types of services they provide to management, (b) typical structure of venture-capital firms and their sources of funds, and (c) how they get their money back, (d) economic justification for the returns they earn, and (e) the allocation of the profits from investmens among the participants in a venture-capital fund. Be explicit and use the appropriate industry vocabulary.FBE 432 - Midterm ExaminationA N S W E R S T O P R A C T I C E Q U E S T I O N SFBE 432 - Midterm ExaminationMarch 8, 2001P R A C T I C E Q U E S T I O N SName______________________________________ Student No.__________________PART I - MULTIPLE CHOICE - WRITE YOUR NAME AND MARK BEST ANSWERS ON SCANTRON.1. Using market comparables to value firms results in a. under-valuation of firms.b. over-valuation of firms.c. exact valuation of firms.d. the worst estimated values.e. None of the above.2. Examples of market comparables used in valuation are all of the following except a. price-to-book ratio.b. price-earnings ratio.c. sales-to-asset ratio.d. times-interest-earned ratio.e. cash-flow-to-value ratio.3. As an issuer of a fixed-income debt security who believes interest rates will fall, you coulda. enter swap to receive fixed and pay a variable rate.b. enter a swap to pay fixed and receive a variable rate.c. Sell calls.d. Buy puts.e. All of the above.4. Discounted cash flow estimates of value are better because they avoida. under-valuation of firms.b. over-valuation of firms.c. problems with estimated costs of capital.d. forecasting errors in estimated values.e. None of the above.5. Venture-capital investors expect returns approximately equal toa. long-term government bond rate.b. CAPM cost of capital.c. Treasury bill rate.d. average return on equities since 1927.e. None of the above. 6. If the risk-free rate is 6 percent, a firm’s beta is 1.5, and the risk-premium is 8 percent, the firm’s cost of equity is approximatelya. 6 percent.b. 8 percent.c. 9 percent.d. 14 percent.e. Higher than any of the above rates of return.7. If the firm in question 6 had a debt-equity ratio of 1.0, the firm’s unlevered cost of capital would bea. 10 percent.b. 12 percent.c. 14 percent.d. 18 percent.e. Cannot be determined from the data provided.8. Debt should be considered as a source of financing for a firm becausea. debt changes the business risk of the firm.b. debt reduces the overall financial risk of the firm.c. interest is tax deductable.d. investors pay a premium for leverage e. debt is virtually free money.FBE 432 - Midterm ExaminationMarch 8, 2001P R A C T I C E Q U E S T I O N SName______________________________________ Student No.__________________PART II - LONGER ANSWERS - WRITE ANSWERS IN SPACE PROVIDED. 1. Venture capitalists provide a useful role in an economy, but they expect to earn high rates of return. Discuss the role venture capitalists play with start-up firms in terms of the (a) types of services they provide to management, (b) typical structure of venture-capital firms and their sources of funds, and (c) how they get their money back, (d) economic justification for the returns they earn, and (e) the allocation of the profits from investmens among the participants in a venture-capital fund. Be explicit and use the appropriate industry vocabulary.2. Use the following quotes from the March 2, 2001, Wall Street Journal in answering this question:FUTURES PRICES: INTEREST RATES FUTURES OPTIONS PRICESEURODOLLAR (CME) - $1 MILLION; PTS OF 100% EURODOLLAR (CME) Yield Open ($ million pts of 100%) Open High Low Settle Chg Settle Chg Interest Strike Calls-Settle Puts-SettleMar01 94.98 95.01 94.98 95.00 +.01 5.00 -.01 565,662 Price Mar Apr May Mar Apr MayApr 95.12 95.13 95.11 95.12 +.01 4.88 -.01 13,469 9475 2.65 5.45 … 0.07 0.10. …May 95.22 95.22 95.18 95.21 … 4.79 … 1,280 9500 0.70 3.20 3.55 0.62 0.35 0.70a. A bank is issuing CDs in April, 2001, to finance a $10 million fixed loan investment. What is the bank’s exposure (long or short)? How could it hedge its interest rate risk using Eurodollar futures? What borrowing costs could the bank lock into? What happens to the bank’s income statement if rates go to 8% (annualized)?b. What options contract could the bank use? Contrast the cost of using options and futures contracts.c. It is possible to get the same price exposure from buying and selling options as from a futures contract. Using a diagram, show which options reproduce the price risk exposure of a long position in thefutures market. d. Is there an arbitrage opportunity from buying and selling options and going long/short in the futures market? Demonstrate the basis of your answer using the above quotes.FBE 432 - Midterm ExaminationMarch 8, 2001A N S W E R S T O P R A C T I C E Q U E S T I O N SPart I1. e2. d3. a4. e5. e6. e7. b8. cPart II1. (a) Venture capitalists provide seed money, first- and second-round and mezzanine financing for start-up or emerging firms and provide funding for corporate spin-offs and leveraged buy-outs coming from restructuring of existing firms. In addition to funds, venture capitalists monitor firms and provide advice in areas like strategy and staffing, and often find replacements for ineffective or incompetent management. (b) Most venture capital firms are structured as partnerships, with the investments selected and monitoring and other services provided by the general partners and funds provided by limited partners. The limited partners can be wealthy individuals, financial institutions, or pension or other institutional funds. (c) The venture capital funds generally get their money out when the firm they are financing goes publicin an initial public offering (IPO) or is acquired by another firm. (d) The high returns for venture capital are justified by the high risks; many investments are either complete failures or return negative or no profits. A few big winners are required to justify the risks for investors. (e) Profits from venture capitalist are general