BMO Financial Management 2 — Questions and Answers
Question 1: A company has a current ratio of 0.8. What does this indicate?
- The company has more current liabilities than current assets (Correct answer)
- The company is highly profitable
- The company has excess working capital
- The company's debt-to-equity ratio is below 1
Correct answer: The company has more current liabilities than current assets
A current ratio below 1.0 means current liabilities exceed current assets, signaling potential short-term liquidity problems.
Question 2: Which capital budgeting method ignores the time value of money?
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Payback Period (Correct answer)
- Discounted Cash Flow (DCF)
Correct answer: Payback Period
The payback period simply measures how long it takes to recover an investment without discounting future cash flows.
Question 3: What is the primary purpose of a cash flow statement?
- To show the company's net worth
- To report revenues and expenses
- To show cash inflows and outflows over a period (Correct answer)
- To list all company assets and liabilities
Correct answer: To show cash inflows and outflows over a period
The cash flow statement tracks actual cash movement from operating, investing, and financing activities.
Question 4: When a bond is issued at a discount, the bond's coupon rate is:
- Higher than the market interest rate
- Lower than the market interest rate (Correct answer)
- Equal to the market interest rate
- Not related to the market interest rate
Correct answer: Lower than the market interest rate
Bonds sell at a discount when their coupon rate is below prevailing market rates, making them less attractive at face value.
Question 5: Which ratio measures how efficiently a company uses its assets to generate sales?
- Return on equity
- Asset turnover ratio (Correct answer)
- Quick ratio
- Debt ratio
Correct answer: Asset turnover ratio
Asset turnover ratio (Sales ÷ Total Assets) measures how effectively management uses assets to generate revenue.
Question 6: A company reports EBIT of $500,000 and interest expense of $100,000. What is the interest coverage ratio?
- 4.0
- 5.0 (Correct answer)
- 0.2
- 6.0
Correct answer: 5.0
Interest coverage ratio = EBIT ÷ Interest Expense = $500,000 ÷ $100,000 = 5.0.
Question 7: In financial management, 'hedging' is primarily used to:
- Maximize speculative returns
- Reduce or offset financial risk (Correct answer)
- Increase leverage in a portfolio
- Accelerate accounts receivable collection
Correct answer: Reduce or offset financial risk
Hedging involves taking offsetting positions to protect against adverse price or rate movements, thereby reducing risk exposure.
BMO Financial Management 2
A company has a current ratio of 0.8.
What does this indicate?