PRC-3 · Chapter 4
Sources of Business Finance MCQs with Answers
65 multiple-choice questions on Sources of Business Finance for PRC-3 Business & Economic Insights. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
What is the primary objective of financial management decisions in a commercial corporation?
- A) To maximize the number of employees
- B) To maximize value for shareholders
- C) To increase total tax liabilities
- D) To completely eliminate all business expenses
Show answer & explanation
Answer: B) To maximize value for shareholders
The ultimate goal of financial management and financing decisions is to achieve value maximization for the company's shareholders.
Question 2
A retail business takes a loan to cover its inventory purchases for the upcoming holiday season and plans to repay it within six months. How is this type of financing classified?
- A) Long-term equity
- B) Long-term debt
- C) Short-term financing
- D) Retained earnings
Show answer & explanation
Answer: C) Short-term financing
Finances that are intended to be paid off within one year, such as covering seasonal inventory, are classified as short-term financing.
Question 3
A furniture manufacturer receives raw wood from a supplier and agrees to pay the invoice in 45 days without any interest. What specific type of financing is the manufacturer utilizing?
- A) Trade credit
- B) Factoring
- C) Corporate bond
- D) Operating lease
Show answer & explanation
Answer: A) Trade credit
Trade credit exists when a purchaser orders and receives goods but pays the supplier after a mutually agreed upon period of time.
Question 4
When a company is choosing between issuing new shares (equity) or taking a bank loan (debt), what is a major financial advantage of choosing the bank loan?
- A) Debt does not require repayment
- B) Debt grants voting rights to the bank
- C) Interest paid on debt is usually tax-deductible
- D) Debt decreases the span of control
Show answer & explanation
Answer: C) Interest paid on debt is usually tax-deductible
A key advantage of debt financing over equity is that the interest payments made on debt are typically treated as tax-deductible expenses.
Question 5
At the end of the year, Delta Corp decides to keep 40% of its net profit to fund a new factory rather than paying it out to investors. What is this internal source of finance called?
- A) Trade credit
- B) Retained earnings
- C) Debentures
- D) Factoring
Show answer & explanation
Answer: B) Retained earnings
Retaining earnings involves keeping a portion of the business's profits for reinvestment instead of distributing them to shareholders as dividends.
Question 6
A startup tech company issues new shares to a group of investors to raise capital. What is a potential drawback of this equity financing method for the original founders?
- A) They must pay fixed monthly interest
- B) It increases the company's debt burden
- C) It dilutes their ownership and control of the company
- D) The financing must be repaid within one year
Show answer & explanation
Answer: C) It dilutes their ownership and control of the company
Issuing new shares means new investors gain voting rights, resulting in the dilution of ownership and control for existing shareholders.
Question 7
A textile firm has Rs. 1 million in unpaid customer invoices but needs cash immediately to pay salaries. The firm sells these invoices to a financial institution at a discount. What is this financing method called?
- A) Leasing
- B) Factoring
- C) Issuing debentures
- D) Trade credit
Show answer & explanation
Answer: B) Factoring
Factoring is a short-term finance method where a business sells its accounts receivable (invoices) to a third party at a discount to obtain immediate cash.
Question 8
To fund a multi-year infrastructure project, a public limited company issues certificates to the public promising to pay a fixed interest rate and return the principal after 10 years. What are these instruments called?
- A) Ordinary shares
- B) Corporate bonds or debentures
- C) Retained earnings
- D) Promissory trade credits
Show answer & explanation
Answer: B) Corporate bonds or debentures
Corporate bonds and debentures are long-term debt instruments issued to the public to borrow money for extended periods.
Question 9
A financial manager is evaluating two investment projects. Project A is very safe, while Project B is highly uncertain. According to the risk-return trade-off concept, what must Project B offer to be considered viable?
- A) A higher potential return
- B) A lower potential return
- C) Guaranteed government subsidies
- D) Immediate short-term liquidity
Show answer & explanation
Answer: A) A higher potential return
The risk-return trade-off dictates that higher levels of risk must be compensated with the potential for higher returns.
Question 10
A manufacturing firm takes out a 6-month bank loan to purchase heavy machinery that will take 5 years to generate enough cash to pay for itself. What financial risk is the firm creating?
- A) Asset-liability mismatch
- B) Equity dilution
- C) Loss of voting rights
- D) Dividend deficit
Show answer & explanation
Answer: A) Asset-liability mismatch
Funding long-term assets with short-term liabilities creates an asset-liability mismatch, leading to a high risk of default when the loan comes due.
Question 11
Which of the following highlights a primary difference between Financial Accounting and Management Accounting?
- A) Financial accounting is exclusively meant for internal managers; Management accounting is published to the public.
- B) Financial accounting focuses on past, historical data for external stakeholders; Management accounting focuses on forward-looking analysis to aid internal decision-making.
- C) Neither is regulated by standard-setting bodies.
- D) Management accounting focuses only on the total company, while financial accounting details individual departments.
Show answer & explanation
Answer: B) Financial accounting focuses on past, historical data for external stakeholders; Management accounting focuses on forward-looking analysis to aid internal decision-making.
Financial accounting produces historical, regulated reports for external stakeholders (investors, tax authorities). Management accounting produces customized, forward-looking reports for internal managers to plan and control operations.
Question 12
A bakery owner calculates that precisely 0.5 kg of flour and 2 eggs are physically traceable into every single cake produced. These costs are classified as:
- A) Indirect costs
- B) Fixed overheads
- C) Direct costs
- D) Administrative expenses
Show answer & explanation
Answer: C) Direct costs
Direct costs are costs that can be specifically and exclusively identified with and traced to a particular cost object (like the materials in a specific cake).
Question 13
The factory rent for the bakery is Rs. 500,000 per month, regardless of whether they bake 1,000 cakes or 10,000 cakes. The rent is an example of a:
- A) Variable cost
- B) Direct material cost
- C) Fixed cost
- D) Semi-variable cost
Show answer & explanation
Answer: C) Fixed cost
Fixed costs remain constant in total regardless of the volume of production or activity within a relevant range.
Question 14
A piece of machinery costs a company Rs. 1 million. After deciding to close that factory entirely, they find they cannot return or resell the machinery. In management decision-making regarding future projects, this Rs. 1 million is a:
- A) Sunk cost
- B) Relevant cost
- C) Variable cost
- D) Opportunity cost
Show answer & explanation
Answer: A) Sunk cost
A sunk cost is a cost that has already been incurred and cannot be recovered. Therefore, it is irrelevant for future decision-making.
Question 15
A student decides to study full-time for their CA exams instead of taking a job that pays Rs. 50,000 per month. What economic term describes the lost potential income of Rs. 50,000?
- A) Marginal cost
- B) Opportunity cost
- C) Sunk cost
- D) Fixed cost
Show answer & explanation
Answer: B) Opportunity cost
Opportunity cost is the value of the next best alternative forgone as the result of making a decision.
Question 16
What is universally considered the primary, overarching objective of corporate financial management?
- A) To eliminate all corporate debt
- B) To maximize value for the shareholders
- C) To increase the company's headcount
- D) To minimize tax payments completely
Show answer & explanation
Answer: B) To maximize value for the shareholders
The fundamental goal of financial management is to maximize the overall value of the firm for its owners, the shareholders.
Question 17
A manufacturer purchases raw materials in bulk and relies on a common financing method where the supplier allows them 60 days to pay the invoice. What is this called?
- A) Term loan
- B) Corporate bond
- C) Equity financing
- D) Trade credit
Show answer & explanation
Answer: D) Trade credit
Trade credit is a short-term, often interest-free financing arrangement provided by suppliers allowing delayed payment for goods.
Question 18
A textile firm is experiencing a cash shortage and needs money to pay wages immediately. They sell their unpaid customer invoices to a bank at a 5% discount. What short-term financing method is this?
- A) Issuing debentures
- B) Discounting or Factoring of receivables
- C) Trade credit
- D) Retained earnings
Show answer & explanation
Answer: B) Discounting or Factoring of receivables
Factoring or discounting involves selling accounts receivable to a financial institution at a discount to obtain immediate cash.
Question 19
Which of the following describes an essential characteristic of debt financing (such as a bank loan)?
- A) It does not have a maturity date
- B) It gives the lender voting rights in the company
- C) It requires the payment of regular interest and repayment of the principal
- D) The interest payments are not tax-deductible
Show answer & explanation
Answer: C) It requires the payment of regular interest and repayment of the principal
Debt financing obligates the borrower to pay a specific interest rate and return the borrowed principal by a stated maturity date.
Question 20
When comparing debt to equity, what is a major financial advantage of using debt to fund business expansion?
- A) Debt never has to be repaid
- B) The interest paid on debt is usually tax-deductible
- C) Debt dilutes the ownership of existing shareholders
- D) Lenders absorb all business losses
Show answer & explanation
Answer: B) The interest paid on debt is usually tax-deductible
A key advantage of debt is that interest payments are treated as business expenses, which reduces the company's taxable income.
Question 21
A firm needs funding for a new 10-year infrastructure project. Which of the following would be an inappropriate method of financing this long-term asset?
- A) Issuing new equity shares
- B) Retaining earnings
- C) Using a short-term 6-month bank overdraft
- D) Issuing a 10-year corporate bond
Show answer & explanation
Answer: C) Using a short-term 6-month bank overdraft
Using short-term finance for long-term projects creates an asset-liability mismatch, exposing the firm to severe liquidity risks.
Question 22
If an organization wants to raise long-term finance without diluting control, increasing its debt burden, or paying interest, what internal source should it use?
- A) Retained earnings
- B) Bank loans
- C) Issuing preference shares
- D) Corporate bonds
Show answer & explanation
Answer: A) Retained earnings
Retained earnings represent internal profits kept by the company rather than paid as dividends. It involves no new debt and no new voting shareholders.
Question 23
A rapidly growing private tech company decides to list itself on the stock exchange to raise massive equity capital. What is this initial process called?
- A) Factoring
- B) Initial Public Offering (IPO)
- C) Debt restructuring
- D) Leasing
Show answer & explanation
Answer: B) Initial Public Offering (IPO)
An IPO is the process where a previously private company issues shares to the public on a stock exchange for the first time.
Question 24
Which of the following financial instruments represents long-term public debt where the company issues certificates promising to pay fixed interest?
- A) Ordinary shares
- B) Trade credit
- C) Corporate bonds or debentures
- D) Bank overdrafts
Show answer & explanation
Answer: C) Corporate bonds or debentures
Bonds and debentures are formal debt instruments issued to the public to secure long-term capital in exchange for regular interest payments.
Question 25
In financial management, the principle that investors demand higher compensation for undertaking highly uncertain investments is known as the:
- A) Asset-liability mismatch
- B) Risk-return trade-off
- C) Debt-equity ratio
- D) Time value of money
Show answer & explanation
Answer: B) Risk-return trade-off
The risk-return trade-off dictates that the potential return on an investment must increase as the level of risk associated with it increases.
Question 26
Which of the following is a core, fundamental principle of Islamic Banking compared to conventional banking?
- A) Charging compounded interest on corporate loans
- B) The strict prohibition of Riba (interest)
- C) Investing heavily in speculative derivatives
- D) Guaranteeing fixed returns regardless of business performance
Show answer & explanation
Answer: B) The strict prohibition of Riba (interest)
Unlike conventional banking which relies on interest, Islamic banking operates on profit-sharing and asset-backed transactions, strictly prohibiting Riba (interest).
Question 27
Which of the following terms represents a recognized mode of financing in Islamic Banking?
- A) Compound interest loans
- B) Unsecured overdrafts
- C) Mudarabah
- D) Conventional bonds
Show answer & explanation
Answer: C) Mudarabah
Mudarabah (along with Murabaha, Musharakah, and Ijara) is a standard profit-sharing partnership model used in Islamic finance.
Question 28
A supermarket receives weekly shipments of fresh produce and has an agreement with the farmers to pay for the deliveries 30 days after they arrive. What type of short-term finance is this?
- A) Factoring
- B) Trade credit
- C) Bank overdraft
- D) Corporate debenture
Show answer & explanation
Answer: B) Trade credit
Trade credit is a short-term financing arrangement where suppliers allow businesses to delay payment for goods and services they have already received.
Question 29
A clothing manufacturer has Rs. 2 million tied up in unpaid invoices from retailers but desperately needs cash to pay rent. The manufacturer sells these invoices to a finance company for Rs. 1.9 million cash today. What is this called?
- A) Retained earnings
- B) Issuing equity
- C) Factoring of receivables
- D) Operating lease
Show answer & explanation
Answer: C) Factoring of receivables
Factoring (or discounting) involves selling accounts receivable (invoices) to a third party at a discount to secure immediate liquidity.
Question 30
A small business sets up an arrangement with its bank allowing it to withdraw up to Rs. 500,000 more than it actually has in its current account, paying daily interest on the overdrawn amount. What is this financing called?
- A) Long-term loan
- B) Bank overdraft
- C) Debenture
- D) Initial Public Offering
Show answer & explanation
Answer: B) Bank overdraft
A bank overdraft is a flexible short-term borrowing facility where a bank allows a business to withdraw funds beyond its account balance up to an agreed limit.
Question 31
A successful private software firm wants to expand globally and decides to sell shares to the general public on the stock market for the first time. This specific capital-raising event is known as an:
- A) Initial Public Offering (IPO)
- B) Internal debt restructuring
- C) Open market operation
- D) Overdraft extension
Show answer & explanation
Answer: A) Initial Public Offering (IPO)
An IPO is the very first time a privately held company issues shares to the public to raise equity capital.
Question 32
At the end of a profitable year, a company's board decides not to pay any dividends and instead uses all the profits to buy new machinery. Which internal source of finance is being utilized?
- A) Factoring
- B) Retained earnings
- C) Preference shares
- D) Trade credit
Show answer & explanation
Answer: B) Retained earnings
Retained earnings refer to the portion of net income that is kept by the corporation rather than distributed to shareholders as dividends.
Question 33
To finance a new bridge, a company issues long-term certificates to public investors, promising to pay them 8% interest annually and return their principal in 15 years. What are these certificates called?
- A) Ordinary equity shares
- B) Trade credits
- C) Corporate bonds or debentures
- D) Short-term promissory notes
Show answer & explanation
Answer: C) Corporate bonds or debentures
Bonds and debentures are long-term debt instruments issued to the public, carrying a fixed interest rate and a set maturity date.
Question 34
When a firm is choosing between issuing new shares or taking a bank loan, what is a key financial advantage of choosing the bank loan?
- A) The loan does not have to be repaid
- B) The interest payments are generally tax-deductible expenses
- C) The bank will absorb all business losses
- D) The bank receives voting rights on the board
Show answer & explanation
Answer: B) The interest payments are generally tax-deductible expenses
A major advantage of debt financing is that interest payments reduce the firm's taxable income, creating a 'tax shield'.
Question 35
What is a major disadvantage for original founders when they raise capital by issuing new ordinary shares to external investors?
- A) They must pay fixed interest every month
- B) It causes a dilution of ownership and control
- C) It increases the company's risk of bankruptcy
- D) The capital must be repaid within one year
Show answer & explanation
Answer: B) It causes a dilution of ownership and control
Issuing new equity means bringing in new co-owners, which dilutes the voting power and profit share of the existing shareholders.
Question 36
Under Islamic banking principles, a partnership is formed where one party provides the capital and the other provides management expertise, and they share profits according to a pre-agreed ratio. What is this arrangement called?
- A) Riba
- B) Overdraft
- C) Mudarabah
- D) Conventional Bond
Show answer & explanation
Answer: C) Mudarabah
Mudarabah is an Islamic finance concept where a financier provides capital and an entrepreneur provides labor, sharing profits but only the financier bears financial loss.
Question 37
A fundamental difference between conventional banking and Islamic banking is that Islamic banking strictly prohibits the payment or receipt of:
- A) Business profits
- B) Tangible assets
- C) Riba (interest)
- D) Management fees
Show answer & explanation
Answer: C) Riba (interest)
Islamic banking operates on the principle of risk-sharing and asset-backed transactions, strictly forbidding Riba (interest or usury).
Question 38
A logistics firm uses a 3-month overdraft to purchase a fleet of heavy trucks that will take 8 years to generate enough revenue to pay for themselves. What dangerous financial situation has the firm created?
- A) Asset-liability mismatch
- B) Dilution of equity
- C) Optimal capital structure
- D) Dividend deficit
Show answer & explanation
Answer: A) Asset-liability mismatch
Funding long-term assets with short-term liabilities creates a severe asset-liability mismatch, exposing the firm to liquidity crises when the short-term debt is due.
Question 39
A textile wholesaler severely lacks short-term funds to pay its factory workers, but it holds a large number of unpaid customer invoices. The wholesaler sells these invoices to a bank at a slight discount for immediate cash. What is this financing method?
- A) Issuing public debentures
- B) Discounting or Factoring of receivables
- C) Retaining earnings
- D) Securing an operating lease
Show answer & explanation
Answer: B) Discounting or Factoring of receivables
Factoring or discounting is a popular short-term finance method where a business sells its accounts receivable (invoices) to a third party to obtain immediate liquidity.
Question 40
A manufacturer has Rs. 5 million in outstanding customer invoices but needs cash today to pay suppliers. A bank agrees to buy these invoices for Rs. 4.7 million in immediate cash. What is this financing method?
- A) Retained earnings
- B) Factoring / Discounting of receivables
- C) Issuing corporate bonds
- D) Operating lease
Show answer & explanation
Answer: B) Factoring / Discounting of receivables
Factoring or discounting involves outright selling accounts receivable to a financial institution at a discount to obtain quick access to funds.
Question 41
A logistics company acquires a fleet of trucks under an agreement where it pays monthly installments for 5 years. At the end of the 5 years, the company pays a negotiated final price and legally owns the trucks. This is a:
- A) Short-term overdraft
- B) Operating lease
- C) Finance lease
- D) Trade credit
Show answer & explanation
Answer: C) Finance lease
In a finance lease, the lessee effectively pays for the full value of the asset over time and usually has the option to retain ownership at the end of the lease term.
Question 42
Instead of buying a heavy crane, a construction firm rents it for 6 months for a specific project and returns it to the owner afterward. What type of financing arrangement is this?
- A) Operating lease
- B) Finance lease
- C) Debenture
- D) Equity finance
Show answer & explanation
Answer: A) Operating lease
An operating lease is a short-to-medium term rental agreement where the lessee uses the asset but does not intend to take ownership at the end.
Question 43
A highly successful private tech firm wants to raise massive capital to build a new campus. It decides to offer its shares to the general public on the stock market for the very first time. This is called:
- A) Rights issuance
- B) Placement of shares
- C) Initial Public Offering (IPO)
- D) Debt restructuring
Show answer & explanation
Answer: C) Initial Public Offering (IPO)
An IPO is the process where a private company issues its shares to the general public for the first time via a stock exchange.
Question 44
If a company decides to issue new shares, but only offers them to a selected, restricted group of wealthy institutional investors rather than the general public, this process is termed:
- A) Initial Public Offering (IPO)
- B) Placement of shares
- C) Factoring
- D) Open market operation
Show answer & explanation
Answer: B) Placement of shares
A private placement involves selling shares to a small, pre-selected group of investors rather than conducting a public offering.
Question 45
A public utility company issues certificates to public investors promising to pay 9% interest annually and repay the principal amount after 10 years. What is the financial term for these instruments?
- A) Ordinary shares
- B) Trade credits
- C) Promissory overdrafts
- D) Bonds / Debentures
Show answer & explanation
Answer: D) Bonds / Debentures
Bonds and debentures are formal, long-term debt instruments issued to raise capital, characterized by fixed interest payments and a set maturity date.
Question 46
A supermarket receives daily shipments of milk from a dairy farm, but the contract allows the supermarket 30 days to pay the invoices. This short-term financing mode is known as:
- A) Factoring
- B) Trade credit
- C) Corporate bonding
- D) Equity financing
Show answer & explanation
Answer: B) Trade credit
Trade credit is an arrangement where a supplier allows a business to receive goods immediately and pay for them at a later date.
Question 47
A business faces a sudden cash shortage and arranges with its bank to withdraw Rs. 200,000 more than what is currently in its checking account to pay salaries. This short-term borrowing is called:
- A) Long-term loan
- B) Initial Public Offering
- C) Bank overdraft
- D) Mudarabah
Show answer & explanation
Answer: C) Bank overdraft
A bank overdraft is a facility that allows an account holder to continue withdrawing money even when the account balance drops below zero, up to an agreed limit.
Question 48
At the end of the year, Alpha Corp generated Rs. 50 million in net profit. The board decides to keep Rs. 30 million inside the business to fund a new project instead of paying it out to shareholders. This Rs. 30 million is:
- A) A dividend
- B) Retained earnings
- C) A corporate bond
- D) Factored cash
Show answer & explanation
Answer: B) Retained earnings
Retained earnings are the portion of a company's net income that is not distributed as dividends but is instead reinvested into the business.
Question 49
When a firm chooses debt financing over equity financing, what is a primary tax advantage of this choice?
- A) Debt principal repayments are deducted from sales
- B) Interest paid on debt is typically a tax-deductible expense
- C) Lenders pay all the corporate taxes for the firm
- D) Debt completely exempts the firm from income tax
Show answer & explanation
Answer: B) Interest paid on debt is typically a tax-deductible expense
A key advantage of debt is the 'tax shield' it provides, as interest payments are treated as expenses that reduce taxable profit.
Question 50
In Islamic banking, an arrangement where a bank provides all the capital and a client provides expertise and labor to run a business, sharing the profits at a pre-agreed ratio, is called:
- A) Riba
- B) Mudarabah
- C) Conventional Overdraft
- D) Promissory Note
Show answer & explanation
Answer: B) Mudarabah
Mudarabah is an Islamic profit-sharing partnership where one party supplies the capital (Rab-ul-mal) and the other supplies the managerial expertise (Mudarib).
Question 51
A core, fundamental principle that distinguishes Islamic banking from conventional banking is the strict prohibition of:
- A) Profit sharing
- B) Riba (interest)
- C) Asset-backed financing
- D) Trade credit
Show answer & explanation
Answer: B) Riba (interest)
Islamic finance prohibits Riba, which means banks cannot charge or pay fixed interest on loans or deposits, relying instead on risk-sharing models.
Question 52
Which of the following represents an internal source of finance for an organization seeking to fund its operations?
- A) Issuing a corporate debenture
- B) Taking a commercial bank loan
- C) Retained earnings
- D) Issuing new equity shares to the public
Show answer & explanation
Answer: C) Retained earnings
On the basis of sources of generation of funds, internal sources include retained earnings and owner's capital, whereas debentures and bank loans are external sources.
Question 53
At the end of a highly profitable year, a company's directors vote to keep 60% of the net income inside the business to purchase new equipment rather than paying it all out to shareholders. This 60% represents:
- A) A dividend yield
- B) Retained earnings
- C) Trade credit
- D) Factored cash
Show answer & explanation
Answer: B) Retained earnings
Retained earnings are a vital internal source of finance, representing the portion of net profit kept by the company to reinvest in growth rather than distributed as dividends.
Question 54
A manufacturer is owed Rs. 2 million by its clients but needs cash immediately to pay taxes. A financial institution buys these outstanding invoices for Rs. 1.85 million cash today. What short-term financing method is this?
- A) Trade credit
- B) Operating lease
- C) Discounting / Factoring of receivables
- D) Equity issuance
Show answer & explanation
Answer: C) Discounting / Factoring of receivables
Factoring or discounting involves selling accounts receivable (unpaid customer invoices) to a third party at a discount to secure immediate liquidity.
Question 55
A retail store receives weekly deliveries of clothing from a factory. The factory's contract allows the retail store to sell the clothes and pay the factory 45 days after delivery. What form of finance is the factory providing?
- A) Bank overdraft
- B) Long-term loan
- C) Trade credit
- D) Mudarabah
Show answer & explanation
Answer: C) Trade credit
Trade credit is a common short-term financing arrangement where suppliers allow businesses delayed payment terms for goods already received.
Question 56
A small business has a cash flow problem and arranges with its bank to withdraw up to Rs. 300,000 more than is actually in its current account, paying daily interest only on the exact amount overdrawn. This facility is called a:
- A) Factoring contract
- B) Corporate debenture
- C) Fixed term loan
- D) Bank overdraft
Show answer & explanation
Answer: D) Bank overdraft
An overdraft is a highly flexible short-term borrowing facility linked to a current account, allowing the holder to draw balance below zero up to a set limit.
Question 57
An airline needs an aircraft for 10 years. It signs a contract where it pays regular installments covering the full cost of the plane, and at the end of 10 years, the airline assumes legal ownership. What type of lease is this?
- A) Operating lease
- B) Finance lease
- C) Short-term rental
- D) Equity lease
Show answer & explanation
Answer: B) Finance lease
In a finance lease, the lessee pays for the entire value of the asset over its useful life and typically assumes ownership at the end of the term, transferring risks and rewards.
Question 58
A multinational firm issues formalized certificates to the public to raise Rs. 5 billion. These certificates promise to pay a fixed 8% interest annually and return the principal in 20 years. What are these certificates?
- A) Ordinary equity shares
- B) Preference shares
- C) Corporate bonds / Debentures
- D) Initial Public Offerings
Show answer & explanation
Answer: C) Corporate bonds / Debentures
Bonds and debentures are formal, long-term debt instruments issued to the public, carrying a contractual obligation to pay fixed interest and repay the principal.
Question 59
A private company wants to raise equity capital but wishes to avoid the complex regulations and public scrutiny of an open stock market listing. Instead, it sells its new shares directly to three large pension funds. This process is a:
- A) Rights issue
- B) Private placement of shares
- C) Initial Public Offering (IPO)
- D) Bank loan syndication
Show answer & explanation
Answer: B) Private placement of shares
A placement of shares involves raising capital by selling equity to a small, pre-selected group of private institutional investors rather than the general public.
Question 60
In Islamic finance, a partnership is formed where an investor provides 100% of the financial capital, and an entrepreneur provides the management expertise. They share profits, but the investor bears all financial loss. This is known as:
- A) Mudarabah
- B) Riba
- C) Conventional Overdraft
- D) Factoring
Show answer & explanation
Answer: A) Mudarabah
Mudarabah is a standard Islamic profit-sharing contract where one party provides capital (Rab-ul-mal) and the other provides effort/expertise (Mudarib).
Question 61
Which of the following practices is strictly forbidden in the Islamic banking system, distinguishing it fundamentally from conventional commercial banking?
- A) Trading in tangible assets
- B) Sharing business profits
- C) Paying or receiving Riba (interest)
- D) Charging administrative fees
Show answer & explanation
Answer: C) Paying or receiving Riba (interest)
The prohibition of Riba (interest or usury) is the foundational principle of Islamic finance, which relies on risk-sharing and asset-backing instead.
Question 62
A firm uses a high-interest, 6-month bank overdraft to purchase a heavy manufacturing machine that will take 10 years to generate enough profit to pay for itself. What severe financial risk has the firm created?
- A) Asset-liability mismatch
- B) Dilution of equity
- C) Redundancy deficit
- D) Optimal capital gearing
Show answer & explanation
Answer: A) Asset-liability mismatch
Using short-term finance to fund long-term assets creates a dangerous asset-liability mismatch, leading to severe liquidity crises when the short-term debt becomes due immediately.
Question 63
When a corporation is deciding its capital structure, what is a primary financial benefit of choosing debt (loans) rather than issuing new equity?
- A) Debt never requires principal repayment
- B) Interest payments on debt are generally tax-deductible expenses
- C) Lenders take on the responsibility of managing the firm
- D) Debt completely dilutes the control of existing founders
Show answer & explanation
Answer: B) Interest payments on debt are generally tax-deductible expenses
A major advantage of debt is the 'tax shield'; interest payments are treated as business expenses, directly reducing the firm's taxable corporate income.
Question 64
What is the primary disadvantage faced by the original founders of a business when they raise massive amounts of capital by continually issuing new ordinary shares to external investors?
- A) They will be forced to pay fixed interest every month
- B) The new shares must be repurchased within one year
- C) Their ownership percentage and voting control of the company is significantly diluted
- D) The business automatically converts into a Not-for-Profit entity
Show answer & explanation
Answer: C) Their ownership percentage and voting control of the company is significantly diluted
Issuing new equity introduces new co-owners, which dilutes both the voting power and the share of future profits held by the original founders.
Question 65
A public company decides to raise additional equity capital. Instead of offering shares to the public, it offers new shares exclusively to its current shareholders in proportion to their existing holdings. This is called a:
- A) Rights issue
- B) Private placement
- C) Initial Public Offering (IPO)
- D) Debt consolidation
Show answer & explanation
Answer: A) Rights issue
A rights issue is an invitation to existing shareholders to purchase additional new shares in the company, usually at a discount, proportional to their existing holding.