0 Suka0 Tidak suka

279 tayangan226 halamanJul 08, 2015

© © All Rights Reserved

PDF, TXT atau baca online dari Scribd

© All Rights Reserved

279 tayangan

© All Rights Reserved

- Principles: Life and Work
- The Intelligent Investor, Rev. Ed
- The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness
- Business Adventures: Twelve Classic Tales from the World of Wall Street
- The Hard Thing About Hard Things: Building a Business When There Are No Easy Answers
- The Nest
- Awaken the Giant Within: How to Take Immediate Control of Your Mental, Emotional, Physical and Financial
- Rich Dad Poor Dad: What The Rich Teach Their Kids About Money - That the Poor and Middle Class Do Not!
- MONEY Master the Game: 7 Simple Steps to Financial Freedom
- The Law of Sacrifice: Lesson 18 from The 21 Irrefutable Laws of Leadership
- Secrets of the Millionaire Mind: Mastering the Inner Game of Wealth
- I Will Teach You to Be Rich, Second Edition: No Guilt. No Excuses. No BS. Just a 6-Week Program That Works
- Secrets of Six-Figure Women: Surprising Strategies to Up Your Earnings and Change Your Life
- Bad Blood: Secrets and Lies in a Silicon Valley Startup
- The Total Money Makeover: A Proven Plan for Financial Fitness
- The Intelligent Investor Rev Ed.
- You Are a Badass at Making Money: Master the Mindset of Wealth
- The Intelligent Investor

Anda di halaman 1dari 226

I.

DEFINITIONS

RISK PREMIUM

a

1. The excess return required from a risky asset over that required from a risk-free asset is

called the:

a. risk premium.

b. geometric premium.

c. excess return.

d. average return.

e. variance.

VARIANCE

b

2. The average squared difference between the actual return and the average return is

called the:

a. volatility return.

b. variance.

c. standard deviation.

d. risk premium.

e. excess return.

STANDARD DEVIATION

c

3. The standard deviation for a set of stock returns can be calculated as the:

a. positive square root of the average return.

b. average squared difference between the actual return and the average return.

c. positive square root of the variance.

d. average return divided by N minus one, where N is the number of returns.

e. variance squared.

NORMAL DISTRIBUTION

d

4. A symmetric, bell-shaped frequency distribution that is completely defined by its mean

and standard deviation is the _____ distribution.

a. gamma

b. Poisson

c. bi-modal

d. normal

e. uniform

GEOMETRIC AVERAGE RETURN

d

5. The average compound return earned per year over a multi-year period is called the

_____ average return.

a. arithmetic

b. standard

c. variant

d. geometric

e. real

CHAPTER 10

ARITHMETIC AVERAGE RETURN

a

6. The return earned in an average year over a multi-year period is called the _____

average return.

a. arithmetic

b. standard

c. variant

d. geometric

e. real

EFFICIENT CAPITAL MARKET

e

7. An efficient capital market is one in which:

a. brokerage commissions are zero.

b. taxes are irrelevant.

c. securities always offer a positive rate of return to investors.

d. security prices are guaranteed by the U.S. Securities and Exchange Commission to be

fair.

e. security prices reflect available information.

EFFICIENT MARKETS HYPOTHESIS

a

8. The notion that actual capital markets, such as the NYSE, are fairly priced is called the:

a. Efficient Markets Hypothesis (EMH).

b. Law of One Price.

c. Open Markets Theorem.

d. Laissez-Faire Axiom.

e. Monopoly Pricing Theorem.

STRONG FORM EFFICIENCY

b

9. The hypothesis that market prices reflect all available information of every kind is

called _____ form efficiency.

a. open

b. strong

c. semi-strong

d. weak

e. stable

SEMI STRONG FORM EFFICIENCY

c

10. The hypothesis that market prices reflect all publicly-available information is called

_____ form efficiency.

a. open

b. strong

c. semi-strong

d. weak

e. stable

CHAPTER 10

WEAK FORM EFFICIENCY

d

11. The hypothesis that market prices reflect all historical information is called _____ form

efficiency.

a. open

b. strong

c. semi-strong

d. weak

e. stable

II. CONCEPTS

TOTAL RETURN

d

12. The total percentage return on an equity investment is computed using the formula

______, where P1 is the purchase cost, P2 represents the sale proceeds, and d is the

dividend income.

a. (P2 P1) (P2 + d)

b. (P1 P2) (P2 + d)

c. (P1 P2 d) P1

d. (P2 P1 + d) P1

e. (P2 P1 + d) P2

DIVIDEND YIELD

a

13. The dividend yield is equal to _____, where P1 is the purchase cost, P2 represents the

sale proceeds, and d is the dividend income.

a. d P1

b. d P1

c. d P2

d. d P2

e. d (P1 + P2)

DIVIDEND YIELD

c

14. The Zolo Co. just declared that they are increasing their annual dividend from $1.00 per

share to $1.25 per share. If the stock price remains constant, then:

a. the capital gains yield will decrease.

b. the capital gains yield will increase.

c. the dividend yield will increase.

d. the dividend yield will also remain constant.

e. neither the capital gains yield nor the dividend yield will change.

CAPITAL GAIN

b

15. The dollar amount of the capital gain on an investment is computed as _____, where P1

is the purchase cost, P2 represents the sale proceeds, and d is the dividend income.

a. P1 P2

b. P2 P1

c. P2 P1

d. P1 P2 + d

e. P2 P1 d

CHAPTER 10

TOTAL RETURN

e

16. The capital gains yield plus the dividend yield on a security is called the:

a. variance of returns.

b. geometric return.

c. average period return.

d. summation of returns.

e. total return.

REAL RETURN

c

17. The real rate of return on a stock is approximately equal to the nominal rate of return:

a. multiplied by (1 + inflation rate).

b. plus the inflation rate.

c. minus the inflation rate.

d. divided by (1 + inflation rate).

e. divided by (1- inflation rate).

REAL RETURN

c

18. As long as the inflation rate is positive, the real rate of return on a security investment

will be ____ the nominal rate of return.

a. greater than

b. equal to

c. less than

d. greater than or equal to

e. unrelated to

HISTORICAL RECORD

d

19. A portfolio of large company stocks would contain which one of the following types of

securities?

a. stock of the firms which represent the smallest 20 percent of the companies listed on the

NYSE

b. U.S. Treasury bills

c. long-term corporate bonds

d. stocks of firms included in the S&P 500 index

e. long-term government bonds

HISTORICAL RECORD

d

20. Based on the period of 1926 through 2003, _____ have tended to outperform other

securities over the long-term.

a. U.S. Treasury bills

b. large company stocks

c. long-term corporate bonds

d. small company stocks

e. long-term government bonds

CHAPTER 10

HISTORICAL RECORD

a

21. Which one of the following types of securities has tended to produce the lowest real

rate of return for the period 1926 through 2003?

a. U.S. Treasury bills

b. long-term government bonds

c. small company stocks

d. large company stocks

e. long-term corporate bonds

HISTORICAL RECORD

d

22. On average, for the period 1926 through 2003:

a. the real rate of return on U.S. Treasury bills has been negative.

b. small company stocks have underperformed large company stocks.

c. long-term government bonds have produced higher returns than long-term corporate

bonds.

d. the risk premium on long-term corporate bonds has exceeded the risk premium on longterm government bonds.

e. the risk premium on large company stocks has exceeded the risk premium on small

company stocks.

HISTORICAL RECORD

e

23. Over the period of 1926 through 2003, the annual rate of return on _____ has been

more volatile than the annual rate of return on_____:

a. large company stocks; small company stocks.

b. long-term government bonds; long-term corporate bonds.

c. U.S. Treasury bills; long-term government bonds.

d. long-term corporate bonds; small company stocks.

e. large company stocks; long-term corporate bonds.

HISTORICAL RECORD

d

24. During the period of 1926 through 2003 the annual rate of inflation:

a. was always positive.

b. was only negative during the 3 years of the Great Depression.

c. never exceeded 10 percent.

d. fluctuated significantly from one year to the next.

e. tended to be negative during the years of World War II.

HISTORICAL RECORD

e

25. Based on the period of 1926 through 2003 the annual rate of inflation ranged from

_____ percent to _____ percent.

a. -5; 6

b. -5; 9

c. -7; 6

d. -7; 15

e. -10; 18

CHAPTER 10

HISTORICAL RECORD

b

26. $1 invested in U.S. Treasury bills in 1926 would have increased in value to ____ by

2003.

a. $10

b. $17

c. $30

d. $43

e. $60

HISTORICAL RECORD

d

27. Which one of the following is a correct ranking of securities based on their volatility

over the period of 1926 to 2003? Rank from highest to lowest.

a. large company stocks, U.S. Treasury bills, long-term government bonds

b. small company stocks, long-term corporate bonds, large company stocks

c. small company stocks, long-term government bonds, long-term corporate bonds

d. large company stocks, long-term corporate bonds, long-term government bonds

e. long-term government bonds, long-term corporate bonds, U.S. Treasury bills

HISTORICAL RECORD

d

28. $1 invested in small company stocks in 1926 would have increased in value to _____ by

2003.

a. $60

b. $2,284

c. $4,092

d. $10,953

e. $13,185

HISTORICAL RECORD

d

29. The highest rate of annual inflation between 1926 and 2003 was_____ percent.

a. 7

b. 10

c. 13

d. 18

e. 22

HISTORICAL RECORD

e

30. The annual return on long-term government bonds has ranged between _____ percent

and _____ percent during the period 1926 to 2003.

a. -2; 8

b. -4; 6

c. -5; 10

d. -6; 29

e. -7; 44

CHAPTER 10

HISTORICAL RECORD

e

31. Over the period of 1926 to 2003, small company stocks had an average return of _____

percent.

a. 8.8

b. 10.2

c. 12.4

d. 14.6

e. 17.5

HISTORICAL AVERAGE RETURNS

c

32. Over the period of 1926 to 2003, the average rate of inflation was _____ percent.

a. 2.0

b. 2.7

c. 3.1

d. 3.8

e. 4.3

HISTORICAL AVERAGE RETURNS

c

33. The average annual return on long-term corporate bonds for the period of 1926 to 2003

was _____ percent.

a. 3.8

b. 5.8

c. 6.2

d. 7.9

e. 8.4

AVERAGE RETURNS

b

34. The average annual return on small company stocks was about _____ percent greater

than the average annual return on large-company stocks over the period of 1926 to

2003.

a. 3

b. 5

c. 7

d. 9

e. 11

RISK PREMIUM

a

35. The average risk premium on U.S. Treasury bills over the period of 1926 to 2003 was

_____ percent.

a. 0.0

b. 1.6

c. 2.2

d. 3.1

e. 3.8

CHAPTER 10

RISK PREMIUM

a

36. Which one of the following is a correct statement concerning risk premium?

a. The greater the volatility of returns, the greater the risk premium.

b. The lower the volatility of returns, the greater the risk premium.

c. The lower the average rate of return, the greater the risk premium.

d. The risk premium is not correlated to the average rate of return.

e. The risk premium is not affected by the volatility of returns.

RISK PREMIUM

c

37. The risk premium is computed by ______ the average return for the investment.

a. subtracting the inflation rate from

b. adding the inflation rate to

c. subtracting the average return on the U.S. Treasury bill from

d. adding the average return on the U.S. Treasury bill to

e. subtracting the average return on long-term government bonds from

RISK PREMIUM

c

38. The excess return you earn by moving from a relatively risk-free investment to a risky

investment is called the:

a. geometric average return.

b. inflation premium.

c. risk premium.

d. time premium.

e. arithmetic average return.

RISK PREMIUM

b

39. To convince investors to accept greater volatility in the annual rate of return on an

investment, you must:

a. decrease the risk premium.

b. increase the risk premium.

c. decrease the expected rate of return.

d. decrease the risk-free rate of return.

e. increase the risk-free rate of return.

FREQUENCY DISTRIBUTION

a

40. Which one of the following takes the shape of a bell curve?

a. frequency distribution

b. variance

c. risk premium graph

d. standard deviation

e. deviation of returns

CHAPTER 10

VARIANCE

e

41. Which of the following statements are correct concerning the variance of the annual

returns on an investment?

I.

The larger the variance, the more the actual returns tend to differ from the average

return.

II. The larger the variance, the larger the standard deviation.

III. The larger the variance, the greater the risk of the investment.

IV. The larger the variance, the higher the expected return.

a. I and III only

b. II, III, and IV only

c. I, III, and IV only

d. I, II, and III only

e. I, II, III, and IV

VARIANCE

a

42. The variance of returns is computed by dividing the sum of the:

a. squared deviations by the number of returns minus one.

b. average returns by the number of returns minus one.

c. average returns by the number of returns plus one.

d. squared deviations by the average rate of return.

e. squared deviations by the number of returns plus one.

STANDARD DEVIATION

b

43. Which of the following statements concerning the standard deviation are correct?

I.

The greater the standard deviation, the lower the risk.

II. The standard deviation is a measure of volatility.

III. The higher the standard deviation, the less certain the rate of return in any one given

year.

IV. The higher the standard deviation, the higher the expected return.

a. I and III only

b. II, III, and IV only

c. I, III, and IV only

d. I, II, and III only

e. I, II, III, and IV

STANDARD DEVIATION

a

44. The standard deviation on small company stocks:

I.

is greater than the standard deviation on large company stocks.

II. is less than the standard deviation on large company stocks.

III. had an average value of about 33 percent for the period 1926 to 2003.

IV. had an average value of about 20 percent for the period 1926 to 2003.

a. I and III only

b. I and II only

c. II and III only

d. II and IV only

e. I and IV only

CHAPTER 10

ARITHMETIC VS. GEOMETRIC AVERAGES

b

45. Estimates using the arithmetic average will probably tend to _____ values over the

long-term while estimates using the geometric average will probably tend to _____

values over the short-term.

a. overestimate; overestimate

b. overestimate; underestimate

c. underestimate; overestimate

d. underestimate; underestimate

e. accurately; accurately

MARKET EFFICIENCY

d

46. In an efficient market, the price of a security will:

a. always rise immediately upon the release of new information with no further price

adjustments related to that information.

b. react to new information over a two-day period after which time no further price

adjustments related to that information will occur.

c. rise sharply when new information is first released and then decline to a new stable

level by the following day.

d. react immediately to new information with no further price adjustments related to that

information.

e. be slow to react for the first few hours after new information is released allowing time

for that information to be reviewed and analyzed.

MARKET EFFICIENCY

c

47. If the financial markets are efficient, then investors should expect their investments in

those markets to:

a. earn extraordinary returns on a routine basis.

b. generally have positive net present values.

c. generally have zero net present values.

d. produce arbitrage opportunities on a routine basis.

e. produce negative returns on a routine basis.

MARKET EFFICIENCY

d

48. Which one of the following statements is correct concerning market efficiency?

a. Real asset markets are more efficient than financial markets.

b. If a market is efficient, arbitrage opportunities should be common.

c. In an efficient market, some market participants will have an advantage over others.

d. A firm will generally receive a fair price when it sells shares of stock.

e. New information will gradually be reflected in a stocks price to avoid any sudden

change in the price of the stock.

MARKET EFFICIENCY

c

49. Financial markets fluctuate daily because they:

a. are inefficient.

b. slowly react to new information.

c. are continually reacting to new information.

d. offer tremendous arbitrage opportunities.

e. only reflect historical information.

CHAPTER 10

MARKET EFFICIENCY

d

50. Insider trading does not offer any advantages if the financial markets are:

a. weak form efficient.

b. semiweak-form efficient.

c. semistrong-form efficient.

d. strong-form efficient.

e. inefficient.

MARKET EFFICIENCY

e

51. According to theory, studying historical prices in order to identify mispriced stocks will

not work in markets that are _____ efficient.

I.

weak-form

II. semistrong-form

III. strong-form

a. I only

b. II only

c. I and II only

d. II and III only

e. I, II, and III

MARKET EFFICIENCY

e

52. Which of the following tend to reinforce the argument that the financial markets are

efficient?

I.

Information spreads rapidly in todays world.

II. There is tremendous competition in the financial markets.

III. Market prices continually fluctuate.

IV. Market prices react suddenly to unexpected news announcements.

a. I and III only

b. II and IV only

c. I, II, and III only

d. II, III, and IV only

e. I, II, III, and IV

MARKET EFFICIENCY

a

53. If you excel in analyzing the future outlook of firms, you would prefer that the financial

markets be ____ form efficient so that you can have an advantage in the marketplace.

a. weak

b. semiweak

c. semistrong

d. strong

e. perfect

CHAPTER 10

MARKET EFFICIENCY

c

54. Your best friend works in the finance office of the Delta Corporation. You are aware

that this friend trades Delta stock based on information he overhears in the office. You

know that this information is not known to the general public. Your friend continually

brags to you about the profits he earns trading Delta stock. Based on this information,

you would tend to argue that the financial markets are at best _____ form efficient.

a. weak

b. semiweak

c. semistrong

d. strong

e. perfect

MARKET EFFICIENCY

c

55. The U.S. Securities and Exchange Commission periodically charges individuals for

insider trading and claims those individuals have made unfair profits. Based on this

fact, you would tend to argue that the financial markets are at best _____ form efficient.

a. weak

b. semiweak

c. semistrong

d. strong

e. perfect

MARKET EFFICIENCY

b

56. Individuals that continually monitor the financial markets seeking mispriced securities:

a. tend to make substantial profits on a daily basis.

b. tend to make the markets more efficient.

c. are never able to find a security that is temporarily mispriced.

d. are always quite successful using only well-known public information as their basis of

evaluation.

e. are always quite successful using only historical price information as their basis of

evaluation.

III. PROBLEMS

DOLLAR RETURNS

b

57. One year ago, you purchased a stock at a price of $32.50. The stock pays quarterly

dividends of $.40 per share. Today, the stock is worth $34.60 per share. What is the

total amount of your dividend income to date from this investment?

a. $.40

b. $1.60

c. $2.10

d. $2.50

e. $3.70

CHAPTER 10

DOLLAR RETURNS

d

58. Six months ago, you purchased 100 shares of stock in ABC Co. at a price of $43.89 a

share. ABC stock pays a quarterly dividend of $.10 a share. Today, you sold all of your

shares for $45.13 per share. What is the total amount of your capital gains on this

investment?

a. $1.24

b. $1.64

c. $40.00

d. $124.00

e. $164.00

DOLLAR RETURNS

d

59. A year ago, you purchased 300 shares of IXC Technologies, Inc. stock at a price of

$9.03 per share. The stock pays an annual dividend of $.10 per share. Today, you sold

all of your shares for $28.14 per share. What is your total dollar return on this

investment?

a. $5,703

b. $5,733

c. $5,753

d. $5,763

e. $5,853

DIVIDEND YIELD

b

60. You purchased 200 shares of stock at a price of $36.72 per share. Over the last year,

you have received total dividend income of $322. What is the dividend yield?

a. 3.2 percent

b. 4.4 percent

c. 6.8 percent

d. 9.2 percent

e. 11.4 percent

DIVIDEND YIELD

d

61. Winslow, Inc. stock is currently selling for $40 a share. The stock has a dividend yield

of 3.8 percent. How much dividend income will you receive per year if you purchase

500 shares of this stock?

a. $152

b. $190

c. $329

d. $760

e. $1,053

DIVIDEND YIELD

c

62. One year ago, you purchased a stock at a price of $32 a share. Today, you sold the stock

and realized a total return of 25 percent. Your capital gain was $6 a share. What was

your dividend yield on this stock?

a. 1.25 percent

b. 3.75 percent

c. 6.25 percent

d. 18.75 percent

e. 21.25 percent

CHAPTER 10

CAPITAL GAIN

a

63. You just sold 200 shares of Langley, Inc. stock at a price of $38.75 a share. Last year

you paid $41.50 a share to buy this stock. Over the course of the year, you received

dividends totaling $1.64 per share. What is your capital gain on this investment?

a. -$550

b. -$222

c. -$3

d. $550

e. $878

CAPITAL GAIN

b

64. You purchased 300 shares of Deltona, Inc. stock for $44.90 a share. You have received

a total of $630 in dividends and $14,040 in proceeds from selling the shares. What is

your capital gains yield on this stock?

a. 4.06 percent

b. 4.23 percent

c. 4.68 percent

d. 8.55 percent

e. 8.91 percent

CAPITAL GAIN

d

65. Today, you sold 200 shares of SLG, Inc. stock.. Your total return on these shares is 12.5

percent. You purchased the shares one year ago at a price of $28.50 a share. You have

received a total of $280 in dividends over the course of the year. What is your capital

gains yield on this investment?

a. 4.80 percent

b. 5.00 percent

c. 6.67 percent

d. 7.59 percent

e. 11.67 percent

TOTAL RETURN

d

66. Six months ago, you purchased 1,200 shares of ABC stock for $21.20 a share. You have

received dividend payments equal to $.60 a share. Today, you sold all of your shares for

$22.20 a share. What is your total dollar return on this investment?

a. $720

b. $1,200

c. $1,440

d. $1,920

e. $3,840

CHAPTER 10

TOTAL RETURN

c

67. Eight months ago, you purchased 400 shares of Winston, Inc. stock at a price of $54.90

a share. The company pays quarterly dividends of $.50 a share. Today, you sold all of

your shares for $49.30 a share. What is your total percentage return on this

investment?

a. -10.2 percent

b. -9.3 percent

c. -8.4 percent

d. 12.0 percent

e. 13.4 percent

REAL RETURN

b

68. Last year, you purchased a stock at a price of $51.50 a share. Over the course of the

year, you received $1.80 in dividends and inflation averaged 2.8 percent. Today, you

sold your shares for $53.60 a share. What is your approximate real rate of return on

this investment?

a. 2.4 percent

b. 4.8 percent

c. 6.2 percent

d. 7.6 percent

e. 10.4 percent

REAL RETURN

e

69. Seven months ago, you purchased a stock at a price of $36.04 a share. Today, you sold

those shares for $43.15 a share. During the past seven months, you have received

dividends totaling $0.24 a share while inflation has averaged 3.6 percent. What is your

approximate real rate of return on this investment?

a. 12.9 percent

b. 13.4 percent

c. 16.1 percent

d. 16.5 percent

e. 16.8 percent

STANDARD DEVIATION

d

70. A stock had returns of 8 percent, -2 percent, 4 percent, and 16 percent over the past four

years. What is the standard deviation of this stock for the past four years?

a. 6.3 percent

b. 6.6 percent

c. 7.1 percent

d. 7.5 percent

e. 7.9 percent

CHAPTER 10

RETURN DISTRIBUTIONS

a

71. A stock has an expected rate of return of 8.3 percent and a standard deviation of 6.4

percent. Which one of the following best describes the probability that this stock will

lose 11 percent or more in any one given year?

a. less than 0.5 percent

b. less than 1.0 percent

c. less than 1.5 percent

d. less than 2.5 percent

e. less than 5 percent

RETURN DISTRIBUTIONS

d

72. A stock has returns of 3 percent, 18 percent, -24 percent, and 16 percent for the past

four years. Based on this information, what is the 95 percent probability range for any

one given year?

a. -8.4 to 11.7 percent

b. -16.1 to 22.6 percent

c. -24.5 to 34.3 percent

d. -35.4 to 41.9 percent

e. -54.8 to 61.3 percent

RETURN DISTRIBUTIONS

c

73. A stock had returns of 8 percent, 14 percent, and 2 percent for the past three years.

Based on these returns, what is the probability that this stock will earn at least 20

percent in any one given year?

a. 0.5 percent

b. 1.0 percent

c. 2.5 percent

d. 5.0 percent

e. 16.0 percent

RETURN DISTRIBUTIONS

c

74. A stock had returns of 11 percent, 1 percent, 9 percent, 15 percent, and -6 percent for

the past five years. Based on these returns, what is the approximate probability that this

stock will earn at least 23 percent in any one given year?

a. 0.5 percent

b. 1.0 percent

c. 2.5 percent

d. 5.0 percent

e. 16.0 percent

RETURN DISTRIBUTIONS

c

75. A stock had returns of 8 percent, 39 percent, 11 percent, and -24 percent for the past

four years. Which one of the following best describes the probability that this stock will

NOT lose more than 43 percent in any one given year?

a. 84.0 percent

b. 95.0 percent

c. 97.5 percent

d. 99.0 percent

e. 99.5 percent

RETURN DISTRIBUTIONS

CHAPTER 10

b

76. Over the past five years, a stock produced returns of 14 percent, 22 percent, -16 percent,

2 percent, and 10 percent. What is the probability that an investor in this stock will

NOT lose more than 8 percent nor earn more than 21 percent in any one given year?

a. 34 percent

b. 68 percent

c. 95 percent

d. 99 percent

e. 100 percent

ARITHMETIC AVERAGE

b

77. What are the arithmetic and geometric average returns for a stock with annual returns

of 4 percent, 9 percent, -6 percent, and 18 percent?

a. 5.89 percent; 6.25 percent

b. 6.25 percent; 5.89 percent

c. 6.25 percent; 8.33 percent

d. 8.3 percent; 5.89 percent

e. 8.3 percent; 6.25 percent

ARITHMETIC VS. GEOMETRIC AVERAGES

c

78. What are the arithmetic and geometric average returns for a stock with annual returns

of 21 percent, 8 percent, -32 percent, 41 percent, and 5 percent?

a. 5.6 percent; 8.6 percent

b. 5.6 percent; 6.3 percent

c. 8.6 percent; 5.6 percent

d. 8.6 percent; 8.6 percent

e. 8.6 percent; 6.3 percent

GEOMETRIC AVERAGE

b

79. A stock had returns of 6 percent, 13 percent, -11 percent, and 17 percent over the past

four years. What is the geometric average return for this time period?

a. 4.5 percent

b. 5.7 percent

c. 6.2 percent

d. 7.3 percent

e. 8.2 percent

CHAPTER 10

GEOMETRIC AVERAGE

b

80. A stock had the following prices and dividends. What is the geometric average return

on this stock?

Year Price Dividend

1

$23.19

2

$24.90 $.23

3

$23.18

$.24

4

$24.86

$.25

a. 3.2 percent

b. 3.4 percent

c. 3.6 percent

d. 3.8 percent

e. 4.0 percent

IV. ESSAYS

EFFICIENT MARKETS

81. Define the three forms of market efficiency.

The student should present a straightforward discussion of weak (all past prices are in the

current price), semi-strong (all public information is in the current price), and strong form

(all information is in the current price) market efficiency.

HISTORICAL RETURNS

82. What securities have offered the highest average annual returns over the last several

decades? Can we conclude that return and risk are related in real life?

The purpose of this question is to check student understanding of the capital market history

discussion of the chapter, as well as to reiterate the concept of the risk-return trade-off. The

securities categories discussed in the chapter are listed below in descending order of

historical returns (and risk):

1.

small company stocks

2.

large company stocks

3.

long-term corporate bonds

4.

long-term government bonds

5.

U.S. Treasury bills

By learning this hierarchy, and given that they are familiar with the attributes of each

security, students should be left with little doubt that the maxim The greater the risk, the

greater the return is an apt description of financial markets.

LESSONS

83. What are the lessons learned from capital market history? What evidence is there to suggest

these lessons are correct?

First, there is a reward for bearing risk, and second, the greater the risk, the greater the

reward. As evidence, the students should provide a brief discussion of the historical rates of

return and standard deviation of returns of the various asset classes discussed in the text.

CHAPTER 10

EFFICIENT MARKETS

84. Explain why it is that in an efficient market, investments have an expected NPV of zero.

In an efficient market, prices are fair so that the cost of an investment is neither too high

nor too low. Thus, on average, investments in that market will yield a zero NPV. Investors

get exactly what they pay for when they buy a security in an efficient market and firms get

exactly what their stocks and bonds are worth when they sell them.

EFFICIENT MARKETS

85. Do you think the lessons from capital market history will hold for each year in the future?

That is, as an example, if you buy small stocks will your investment always outperform

U.S. Treasury bonds?

The student should realize that we are working with averages, so they should not expect

riskier assets to always outperform less risky assets. The student should explain somewhere

in their answer that this gets to the heart of what risk is. That is, the reason you expect to

earn a higher return over the long haul is that your variability in price from year to year can

be significant.

RISK AND RETURN

86. Suppose you have $30,000 invested in the stock market and your banker comes to you and

tries to get you to move that money into the banks certificates of deposit (CDs). He

explains that the CDs are 100% government insured and that you are taking unnecessary

risks by being in the stock market. How would you respond?

The usual response is that bank CDs typically will offer a very low rate of return because

of their low level of risk. Even if students do not know the relationship between yields on

CDs and historical returns on stocks, they should recognize that because of the risk

differences the CDs must have a lower expected return. So, if the investor in the question is

willing to trade off some safety in order to have the chance to earn larger returns, the stock

market is the correct investment.

MARKET EFFICIENCY

87. Suppose your cousin invests in the stock market and doubles her money in a single year

while the market, on average, earned a return of only about 15 percent. Is your cousins

performance a violation of market efficiency?

No, market efficiency does not preclude investors from beating the market. It is entirely

possible to earn higher returns than the market at times. However, if your cousin is able to

do so consistently, then there would certainly be some doubt cast upon market efficiency.

CHAPTER 10

INSIDER TRADING

88. How do you think the stock market would be affected if the laws were changed so that

trading on insider information was no longer illegal? What would be the impact on the goal

of the financial manager if such a change were to occur?

This open-ended question allows students to ponder market efficiency from a different

angle. By allowing insiders to trade on their information, it would be possible for insiders to

take advantage of uninformed investors. This may keep some investors out of the market

because they would perceive the prices observed as no longer being fair. This change

would provide a serious blow to the efficiency of the market and would also further

complicate the issue of whos interest managers are working to satisfy.

MARKET EFFICIENCY

89. Why should a financial decision maker such as a corporate treasurer or CFO be concerned

with market efficiency?

Good answers to this question might indicate that market efficiency is a necessary condition

for the maximize shareholder wealth rule. Unless we are confident that the market price

is an economically meaningful number, seeking to maximize it is silly. Similarly, students

should recognize that there is a very strong link between managerial decisions and the value

of the firm, as reflected in security prices. Finally, as a preview of the cost of capital

discussion in later chapters, instructors might point out that market efficiency ensures that

the required returns on new securities will be directly related to the risk-return profile of the

firm and, therefore, to managerial actions.

()

CH2

CH2

CH1

NPV

1.

2.

3.

4.

5.

6.

a.

stockholders liability.

b.

corporate breakdown.

c.

d.

corporate activism.

e.

legal liability.

a.

b.

c.

d.

e.

the total interest paid to creditors over the lifetime of the firm.

Financial managers should strive to maximize the current value per share of the existing stock because:

a.

doing so guarantees the company will grow in size at the maximum possible rate.

b.

c.

d.

doing so means the firm is growing in size faster than its competitors.

e.

The decisions made by financial managers should all be ones which increase the:

a.

b.

c.

d.

e.

Which one of the following actions by a financial manager creates an agency problem?

a.

refusing to borrow money when doing so will create losses for the firm

b.

refusing to lower selling prices if doing so will reduce the net profits

c.

d.

agreeing to pay bonuses based on the market value of the company stock

e.

increasing current costs in order to increase the market value of the stockholders equity

Which of the following help convince managers to work in the best interest of the stockholders?

I.

II.

IV. threat of conversion to a partnership

1

7.

a.

I and II only

c.

e.

a.

b.

c.

d.

e.

1.C

2.D

3.C

4.D

5.C

6.C

7.B

()

CH2

1.

I. accounts payable

II. long-term debt

III. accounts receivable

IV. Inventory

a. I and II only

c. II and IV only

2.

a. ensures that sufficient equipment is available to produce the amount of product desired on a daily basis.

b. ensures that long-term debt is acquired at the lowest possible cost.

c. ensures that dividends are paid to all stockholders on an annual basis.

d. balances the amount of company debt to the amount of available equity.

e. is concerned with the upper portion of the balance sheet.

3.

a. total liabilities minus shareholders equity.

b. current liabilities minus shareholders equity.

c. fixed assets minus long-term liabilities.

d. total assets minus total liabilities.

e. current assets minus current liabilities.

4.

I. equipment

II. Inventory

IV. Cash

2

a. II and IV only

5.

A _____ standardizes items on the income statement and balance sheet as a percentage of total sales and total

assets, respectively.

a. tax reconciliation statement

b. statement of standardization

c. statement of cash flows

d. common-base year statement

e. common-size statement

6.

Financial ratios that measure a firms ability to pay its bills over the short run without undue stress are known

as _____ ratios.

a. asset management

b. long-term solvency

c. short-term solvency

d. profitability

e. market value

7.

a. current assets minus current liabilities.

b. current assets divided by current liabilities.

c. current liabilities minus inventory, divided by current assets.

d. cash on hand divided by current liabilities.

e. current liabilities divided by current assets.

8.

a. current assets divided by current liabilities.

b. cash on hand plus current liabilities, divided by current assets.

c. current liabilities divided by current assets, plus inventory.

d. current assets minus inventory, divided by current liabilities.

e. current assets minus inventory minus current liabilities.

9.

a. current assets divided by current liabilities.

b. current assets minus cash on hand, divided by current liabilities.

c. current liabilities plus current assets, divided by cash on hand.

d. cash on hand plus inventory, divided by current liabilities.

e. cash on hand divided by current liabilities.

10. The financial ratio measured as total assets minus total equity, divided by total assets, is the:

a. total debt ratio.

b. equity multiplier.

c. debt-equity ratio.

d. current ratio.

11. The debt-equity ratio is measured as total:

a. equity minus total debt.

3

12. Ratios that measure how efficiently a firm uses its assets to generate sales are known as _____ ratios.

a. asset management

b. long-term solvency

c. short-term solvency

d. profitability

e. market value

13. The inventory turnover ratio is measured as:

a. total sales minus inventory.

14. The financial ratio days sales in inventory is measured as:

a. inventory turnover plus 365 days.

b. inventory times 365 days.

c. inventory plus cost of goods sold, divided by 365 days.

d. 365 days divided by the inventory.

e. 365 days divided by the inventory turnover.

15. The receivables turnover ratio is measured as:

a. sales plus accounts receivable.

b. sales divided by accounts receivable.

c. sales minus accounts receivable, divided by sales.

d. accounts receivable times sales.

e. accounts receivable divided by sales.

16. The financial ratio days sales in receivables is measured as:

a. receivables turnover plus 365 days.

b. accounts receivable times 365 days.

c. accounts receivable plus sales, divided by 365 days.

d. 365 days divided by the receivables turnover.

e. 365 days divided by the accounts receivable.

17. The total asset turnover ratio is measured as:

a. sales minus total assets.

e.

1. e 2. e 3. e 4. a 5. e 6. c 7. b 8. d 9. e

11. c 12. a 13. c 14. e 15. b 16. d 17. b

10. a

Ch3 (

()+

)+

)++Ch.2

+Ch.2

1.

Ratios that measure a firms financial leverage are known as _____ ratios.

a. asset management

b. long-term solvency

c. short-term solvency

d. profitability

e. market value

2.

a. equity divided by total assets.

b. equity plus total debt.

c. assets minus total equity, divided by total assets.

d. assets plus total equity, divided by total debt.

e. assets divided by total equity.

3.

The financial ratio measured as earnings before interest and taxes, divided by interest expense is the:

a. cash coverage ratio.

b. debt-equity ratio.

d. gross margin.

4.

The financial ratio measured as earnings before interest and taxes, plus depreciation, divided by interest

expense, is the:

a. cash coverage ratio.

b. debt-equity ratio.

d. gross margin.

5.

Ratios that measure how efficiently a firms management uses its assets and equity to generate bottom line net

income are known as _____ ratios.

a. asset management

b. long-term solvency

c. short-term solvency

d. profitability

e. market value

6.

The financial ratio measured as net income divided by sales is known as the firms:

a. profit margin.

b. return on assets.

c. return on equity.

d. asset turnover.

7.

The financial ratio measured as net income divided by total assets is known as the firms:

a. profit margin.

b. return on assets.

c. return on equity.

d. asset turnover.

8.

The financial ratio measured as net income divided by total equity is known as the firms:

a. profit margin.

b. return on assets.

c. return on equity.

d. asset turnover.

9.

The financial ratio measured as the price per share of stock divided by earnings per share is known as the:

a. return on assets.

b. return on equity.

c. debt-equity ratio.

d. price-earnings ratio.

e. Du Pont identity.

10. The market-to-book ratio is measured as:

a. total equity divided by total assets.

b. net income times market price per share of stock.

c. net income divided by market price per share of stock.

d. market price per share of stock divided by earnings per share.

e. market value of equity per share divided by book value of equity per share.

11. The _____ breaks down return on equity into three component parts.

a. Du Pont identity

b. return on assets

c. statement of cash flows

e. equity multiplier

12. On a common-size balance sheet, all _____ accounts are shown as a percentage of _____.

a. income; total assets

c. asset; sales

e. equity; sales

13. Which one of the following statements is correct concerning ratio analysis?

a. A single ratio is often computed differently by different individuals.

b. Ratios do not address the problem of size differences among firms.

c. Only a very limited number of ratios can be used for analytical purposes.

d. Each ratio has a specific formula that is used consistently by all analysts.

e. Ratios can not be used for comparison purposes over periods of time.

14. Which of the following are liquidity ratios?

I. cash coverage ratio

b. I and II only

15. An increase in which one of the following accounts increases a firms current ratio without affecting its quick

ratio?

a. accounts payable

b. cash

c. inventory

d. accounts receivable

e. fixed assets

16. A supplier, who requires payment within ten days, is most concerned with which one of the following ratios

when granting credit?

a. current

b. cash

c. debt-equity

e. total debt

6

d. quick

17. A firm has a total debt ratio of .47. This means that that firm has 47 cents in debt for every:

a. $1 in equity.

b. $1 in total sales.

c. $1 in current assets.

d. $.53 in equity.

18. A banker considering loaning a firm money for ten years would most likely prefer the firm have a debt ratio

of _____ and a times interest earned ratio of_____ .

a. .75; .75

b. 50; 1.00

c. 45; 1.75

d. 40; 2.50

e. 35; 3.00

a. faster a firm sells its inventory.

b. faster a firm collects payment on its sales.

c. longer it takes a firm to sell its inventory.

d. greater the amount of inventory held by a firm.

e. lesser the amount of inventory held by a firm.

20. Which one of the following statements is correct if a firm has a receivables turnover measure of 10?

a. It takes a firm 10 days to collect payment from its customers.

b. It takes a firm 36.5 days to sell its inventory and collect the payment from the sale.

c. It takes a firm 36.5 days to pay its creditors.

d. The firm has an average collection period of 36.5 days.

e. The firm has ten times more in accounts receivable than it does in cash.

1.b 2.e 3.c 4.a 5.d 6.a 7.b 8.c 9.d 10.e

11.a 12.d 13.a 14.a 15.c 16.b 17.d 18.e 19.a

20.d

()

Ch.4 (

()+

)+

)++Ch.3

+Ch.3

DOL

DOLDFL

DFLDTL

Use the following data to answer Questions 1 and 2.

If Jaycos sales increase by 10%, Jaycos EBIT increases by 15%. If Jaycos EBIT increases by 10%,

Jaycos EPS increases by 12%.

1. Jaycos degree of operating leverage (DOL) and degree of financial leverage (DFL) are closest to:

DOL

DFL

a.

1.8

1.2

b.

1.5

1.2

c.

1.8

1.4

d.

1.5

1.4

2.

a. 1.2.

b. 1.7.

c. 1.8.

7

d. 2.7.

Jayco, Inc. sells 10,000 units at a price of $5 per unit. Jaycos fixed costs are $8,000, interest expense is

$2,000, variable costs are $3 per unit, and EBIT is $12,000.

3.

4.

Jaycos degree of operating leverage (DOL) and degree of financial leverage (DFL) are closest to:

DOL

DFL

a.

b.

1.40

1.40

1.56

1.20

c.

1.67

1.20

d.

1.67

1.56

a. 1.25.

5.

b. 1.50.

c. 1.75.

d. 2.00.

Vischer Concrete has $1.2 million in assets that are currently financed with 100% equity. Vischers

EBIT is $300,000 and its tax rate is 30%. If Vischer changes its capital structure (recapitalizes) to

include 40% debt, what is Vischers ROE before and after the change? Assume that the interest rate

on debt is 5%.

ROE at 100% equity

6.

a.

b.

17.5%

17.5%

37.5%

26.8%

c.

25.0%

26.8%

d.

25.0%

37.5%

Which of the following statements regarding the risks and potential rewards for owners and creditors

of a business is TRUE?

a. The potential reward for creditors is virtually unlimited assuming the business is profitable.

b. In the event of bankruptcy, creditors have a claim to the assets of the firm that must be met before

equity owners receive anything.

c. Owners have less risk than creditors.

d. In exchange for the risk they bear, creditors have the authority to make decisions regarding how

the business is run.

1. b

DOL

DFL

2. c

DTL

3. c

DOL

DFL

4. d

DTL

= (increase in EPS / increase in EBIT) = 0.12 / 0.10 = 1.2

= DOL DFL = 1.2 1.5 = 1.8

= [Q(P - V)] / [Q(P - V) - F] = [10,000 (5 - 3)] / [10,000 (5 - 3) - 8,000] = 1.67

= EBIT / (EBIT - I) = 12,000 / (12,000 - 2,000) = 1.2

= (Q(P-V)) / [Q(P-V)-F-I] = (10,000 (5-3)) / [10,000 (5-3) - 8,000 - 2,000]

= 2.0

8

DTL = DOL DFL = 1.67 1.2 = 2.0

5. b

EBIT

Interest expense

Income before taxes

Taxes at 30%

Net income

Shareholders' equity

ROE = NI / Equity

$300,000

$0

$300,000

$90,000

$210,000

$1,200,000

17.5%

$300,000

$24,000 ($480,000 @ 5%)

$276,000

$82,800

$193,200

$720,000

26.8%

6. b

In the event of bankruptcy, owners do not have a claim to corporate assets until

creditors have been paid in full. Creditors have a less risky position since they are

first in line to receive assets in the event of bankruptcy, but their potential reward

is limited to the promised interest and principal payments on the debt.

()

CH4~5+Ch.5

1.

A firm's sustainable growth rate in sales does not directly depend on its:

a. debt to equity ratio.

b. profit margin.

c. dividend policy.

d. asset efficiency.

2.

The sustainable growth rate will be equivalent to the internal growth rate when:

a. a firm has no debt.

b. the growth rate is positive.

c. the plowback ratio is positive but less than 1.

d. a firm has a debt-equity ratio exactly equal to 1.

e. net income is greater than zero.

3.

a. assumes there is no external financing of any kind.

b. is normally higher than the internal growth rate.

c. assumes the debt-equity ratio is variable.

d. is based on receiving additional external debt and equity financing.

e. assumes that 100% of all income is retained by the firm.

4.

If a firm bases its growth projection on the rate of sustainable growth, and shows positive net income,

then the:

a. fixed assets will have to increase at the same rate, regardless of the current capacity level.

b. number of common shares outstanding will increase at the same rate of growth.

c. debt-equity ratio will have to increase.

d. debt-equity ratio will remain constant while retained earnings increase.

e. fixed assets, debt-equity ratio, and number of common shares outstanding will all increase.

9

5.

Marcies Mercantile wants to maintain its current dividend policy, which is a payout ratio of 40%.

The firm does not want to increase its equity financing but is willing to maintain its current

debt-equity ratio. Given these requirements, the maximum rate at which Marcies can grow is equal

to:

a. 40% of the internal rate of growth.

6.

You are the beneficiary of a life insurance policy. The insurance company informs you that you have

two options for receiving the insurance proceeds. You can receive a lump sum of $50,000 today or

receive payments of $641 a month for ten years. You can earn 6.5% on your money. Which option

should you take and why?

a. You should accept the payments because they are worth $56,451.91 today.

b. You should accept the payments because they are worth $56,523.74 today.

c. You should accept the payments because they are worth $56,737.08 today.

d. You should accept the $50,000 because the payments are only worth $47,757.69 today.

e. You should accept the $50,000 because the payments are only worth $47,808.17 today.

7.

Your employer contributes $25 a week to your retirement plan. Assume that you work for your

employer for another twenty years and that the applicable discount rate is 5%. Given these

assumptions, what is this employee benefit worth to you today?

a. $13,144.43

b. $15,920.55

c. $16,430.54

d. $16,446.34

e. $16,519.02

8.

You have a sub-contracting job with a local manufacturing firm. Your agreement calls for annual

payments of $50,000 for the next five years. At a discount rate of 12%, what is this job worth to you

today?

a. $180,238.81

b. $201,867.47

c. $210,618.19

d. $223,162.58

e. $224,267.10

9.

The Ajax Co. just decided to save $1,500 a month for the next five years as a safety net for

recessionary periods. The money will be set aside in a separate savings account which pays 3.25%

interest compounded monthly. It deposits the first $1,500 today. If the company had wanted to

deposit an equivalent lump sum today, how much would it have had to deposit?

a. $82,964.59

b. $83,189.29

c. $83,428.87

d. $83,687.23

e. $84,998.01

10. You need some money today and the only friend you have that has any is your miserly friend. He

agrees to loan you the money you need, if you make payments of $20 a month for the next six

months. In keeping with his reputation, he requires that the first payment be paid today. He also

charges you 1.5% interest per month. How much money are you borrowing?

a. $113.94

b. $115.65

c. $119.34

d. $119.63

e. $119.96

11. You buy an annuity which will pay you $12,000 a year for ten years. The payments are paid on the

first day of each year. What is the value of this annuity today at a 7% discount rate?

10

a. $84,282.98

b. $87,138.04

c. $90,182.79

d. $96,191.91

e. $116,916.21

12. You are scheduled to receive annual payments of $10,000 for each of the next 25 years. Your

discount rate is 8.5%. What is the difference in the present value if you receive these payments at the

beginning of each year rather than at the end of each year?

a. $8,699

b. $9,217

c. $9,706

d. $10,000

e. $10,850

13. You are comparing two annuities with equal present values. The applicable discount rate is 7.5%.

One annuity pays $5,000 on the first day of each year for twenty years. How much does the second

annuity pay each year for twenty years if it pays at the end of each year?

a. $4,651

b. $5,075

c. $5,000

d. $5,375

e. $5,405

14. Martha receives $100 on the first of each month. Stewart receives $100 on the last day of each month.

Both Martha and Stewart will receive payments for five years. At an 8% discount rate, what is the

difference in the present value of these two sets of payments?

a. $32.88

b. $40.00

c. $99.01

d. $108.00

e. $112.50

15. What is the future value of $1,000 a year for five years at a 6% rate of interest?

a. $4,212.36

b. $5,075.69

c. $5,637.09

d. $6,001.38

e. $6,801.91

16. You borrow $149,000 to buy a house. The mortgage rate is 7.5% and the loan period is 30 years.

Payments are made monthly. If you pay for the house according to the loan agreement, how much

total interest will you pay?

a. $138,086

b. $218,161

c. $226,059

d. $287,086

e. $375,059

17. You retire at age 60 and expect to live another 27 years. On the day you retire, you have $464,900 in

your retirement savings account. You are conservative and expect to earn 4.5% on your money during

your retirement. How much can you withdraw from your retirement savings each month if you plan

to die on the day you spend your last penny?

a. $2,001.96

b. $2,092.05

c. $2,398.17

d. $2,472.00

e. $2,481.27

18. Your local travel agent is advertising an extravagant global vacation. The package deal requires that

you pay $5,000 today, $15,000 one year from today, and a final payment of $25,000 on the day you

leave two years from today. What is the cost of this vacation in todays dollars if the discount rate is

6%?

a. $39,057.41

b. $41,400.85

c. $43,082.39

d. $44,414.14

e. $46,518.00

19. One year ago, the Jenkins Family Fun Center deposited $3,600 in an investment account for the

purpose of buying new equipment four years from today. Today, it is adding another $5,000 to this

11

account. It plans on making a final deposit of $7,500 to the account next year. How much will be

available when it is ready to buy the equipment, assuming it earns a 7% rate of return?

a. $18,159.65

b. $19,430.84

c. $19,683.25

d. $20,194.54

e. $20,790.99

20. What is the future value of the following cash flows at the end of year 3 if the interest rate is 6%? The

cash flows occur at the end of each year.

Year 1

Year 2

Year 3

$5,180

$9,600

$2,250

a. $15,916.78

b. $18,109.08

c. $18,246.25

d. $19,341.02

e. $19,608.07

1.e 2.a 3.b 4.d 5.d 6.a 7.c 8.a 9.b 10.b

11.c 12.a 13.d 14.a 15.c 16.c 17.e 18.b 19.e

20.c

()

CH.6+Ch.7

1.

a. the relationship among interest rates of different bonds with the same maturity.

b. the structure of how interest rates move over time.

c. the relationship among the terms to maturity of different bonds.

d. the relationship among interest rates on bonds with different maturities

2.

a. the structure of how interest rates move over time.

b. the relationship among interest rates of different bonds with the same maturity.

c. the relationship among the terms to maturity of different bonds.

d. the relationship among interest rates on bonds with different maturities.

3.

4.

5.

Which of the following long-term bonds should have the lowest interest rate?

a. Corporate Baa bonds

d. Municipal bonds

Which of the following long-term bonds should have the highest interest rate?

a. Corporate Baa bonds

d. Municipal bonds

a. the riskiness of corporate bonds increases.

b. the liquidity of corporate bonds increases.

c. the liquidity of corporate bonds decreases.

d. the riskiness of corporate bonds decreases.

e. either (b) or (d) occur.

12

6.

7.

8.

a. zero coupon bonds.

b. junk bonds.

a. Brady bonds.

b. junk bonds.

A corporation suffering big losses might be more likely to suspend interest payments on its bonds,

thereby

a. raising the default risk and causing the demand for its bonds to rise.

b. raising the default risk and causing the demand for its bonds to fall.

c. lowering the default risk and causing the demand for its bonds to rise.

d. lowering the default risk and causing the demand for its bonds to fall.

9.

(I) If a corporation suffers big losses, the demand for its bonds will rise because of the higher interest

rates the firm must pay. (II) The spread between the interest rates on bonds with default risk and

default-free bonds is called the risk premium.

a. (I) is true, (II) false.

10. The relationship among interest rates on bonds with identical default risk, but different maturities, is

called the

a. time-risk structure of interest rates.

d. yield curve.

a. upward-sloping.

b. downward-sloping.

c. flat.

12. Typically, yield curves are

a. gently upward-sloping.

b. gently downward-sloping.

c. flat.

d. bowl shaped.

e. mound shaped.

13. When yield curves are steeply upward-sloping,

a. long-term interest rates are above short-term interest rates.

b. short-term interest rates are above long-term interest rates.

c. short-term interest rates are about the same as long-term interest rates.

d. medium-term interest rates are above both short-term and long-term interest rates.

e. medium-term interest rates are below both short-term and long-term interest rates.

14. Economists attempts to explain the term structure of interest rates

a. illustrate how economists modify theories to improve them when they are inconsistent with the

empirical evidence.

13

b. illustrate how economists continue to accept theories that fail to explain observed behavior of

interest rate movements.

c. prove that the real world is a special case that tends to get short shrift in theoretical models.

d. have proved entirely unsatisfactory to date.

15. According to the pure expectations theory of the term structure,

a. the interest rate on long-term bonds will exceed the average of expected future short-term interest

rates.

b. interest rates on bonds of different maturities move together over time.

c. buyers of bonds prefer short-term to long-term bonds.

d. all of the above.

e. only (a) and (b) of the above.

16. According to the pure expectations theory of the term structure,

a. when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the

future.

b. when the yield curve is downward-sloping, short-term interest rates are expected to decline in the

future.

c. buyers of bonds prefer short-term to long-term bonds.

d. all of the above.

e. only (a) and (b) of the above.

17. According to the pure expectations theory of the term structure,

a. when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the

future.

b. when the yield curve is downward-sloping, short-term interest rates are expected to remain

relatively stable in the future.

c. investors have strong preferences for short-term relative to long-term bonds, explaining why yield

curves typically slope upward.

d. all of the above.

e. only (a) and (b) of the above.

18. According to the pure expectations theory of the term structure,

a. yield curves should be as equally likely to slope downward as slope upward.

b. when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the

future.

c. when the yield curve is downward-sloping, short-term interest rates are expected to remain

relatively stable in the future.

d. all of the above.

e. only (a) and (b) of the above.

19. If the expected path of one-year interest rates over the next four years is 5 percent, 4 percent, 2

percent, and 1 percent, then the pure expectations theory predicts that todays interest rate on the

four-year bond is

a. 1 percent.

b. 2 percent.

c. 4 percent.

14

20. If the expected path of one-year interest rates over the next five years is 1 percent, 2 percent, 3

percent, 4 percent, and 5 percent, the pure expectations theory predicts that the bond with the highest

interest rate today is the one with a maturity of

a. one year.

b. two years.

c. three years.

d. four years.

e. five years.

1.d 2.b 3.d 4.a 5.e 6.c 7.b 8.b 9.b 10.d

11.d 12.a 13.a 14.a 15.b 16.e 17.a 18.e 19.d

20.e

()

CH8~CH9CH8~CH9-4

1.

The excess return required from a risky asset over that required from a risk-free asset is called the:

a. risk premium.

b. geometric premium.

c. excess return.

d. average return.

e. variance.

2.

The average squared difference between the actual return and the average return is called the:

a. volatility return.

b. variance.

c. standard deviation.

d. risk premium.

e. excess return.

3.

The standard deviation for a set of stock returns can be calculated as the:

a. positive square root of the average return.

b. average squared difference between the actual return and the average return.

c. positive square root of the variance.

d. average return divided by N minus one, where N is the number of returns.

e. variance squared.

4.

A symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard

deviation is the _____ distribution.

a. gamma

b. Poisson

c. bi-modal

d. normal

e. uniform

5.

The average compound return earned per year over a multi-year period is called the _____ average

return.

a. arithmetic

b. standard

c. variant

d. geometric

e. real

6.

The return earned in an average year over a multi-year period is called the _____ average return.

a. arithmetic

b. standard

c. variant

d. geometric

e. real

7.

The excess return you earn by moving from a relatively risk-free investment to a risky investment is

called the:

15

b. inflation premium.

c. risk premium.

d. time premium.

8.

The capital gains yield plus the dividend yield on a security is called the:

a. variance of returns.

b. geometric return.

d. current yield.

e. total return.

9.

A portfolio of large company stocks would contain which one of the following types of securities?

a. stocks of the firms which represent the smallest 20% of the companies listed on the NYSE

b. U.S. Treasury bills

c. long-term corporate bonds

d. stocks of firms included in the S&P 500 index

e. long-term government bonds

10. Which one of the following is a correct statement concerning risk premium?

a. The greater the volatility of returns, the greater the risk premium.

b. The lower the volatility of returns, the greater the risk premium.

c. The lower the average rate of return, the greater the risk premium.

d. The risk premium is not correlated to the average rate of return.

e. The risk premium is not affected by the volatility of returns.

11. The risk premium is computed by ______ the average return for the investment.

a. subtracting the inflation rate from

b. adding the inflation rate to

c. subtracting the average return on the U.S. Treasury bill from

d. adding the average return on the U.S. Treasury bill to

e. subtracting the average return on long-term government bonds from

12. Which of the following statements are correct concerning the variance of the annual returns on an

investment?

I. The larger the variance, the more the actual returns tend to differ from the average return.

II. The larger the variance, the larger the standard deviation.

III. The larger the variance, the greater the risk of the investment.

IV. The larger the variance, the higher the expected return.

a. I and III only

13. Which of the following statements concerning the standard deviation are correct?

I. The greater the standard deviation, the lower the risk.

II. The standard deviation is a measure of volatility.

III. The higher the standard deviation, the less certain the rate of return in any one given year.

IV. The higher the standard deviation, the higher the expected return.

a. I and III only

16

14. A capital gain occurs when:

a. the selling price is less than the purchase price.

b. the purchase price is less than the selling price.

c. there is no dividend paid.

d. there is no income component of return.

e. never, as they can not exist.

15. Six months ago, you purchased 1,200 shares of ABC stock for $21.20 a share. You have received

dividend payments equal to $.60 a share. Today, you sold all of your shares for $22.20 a share. What

is your total dollar return on this investment?

a. $720

b. $1,200

c. $1,440

d. $1,920

e. $3,840

16. A stock had returns of 8%, -2%, 4%, and 16% over the past four years. What is the standard deviation

of this stock for the past four years?

a. 6.3%

b. 6.6%

c. 7.1%

d. 7.5%

e. 7.9%

17. Over the past five years, a stock produced returns of 14%, 22%, -16%, 2%, and 10%. What is the

probability that an investor in this stock will NOT lose more than 8% nor earn more than 21% in any

one given year?

a. 34%

b. 68%

c. 95%

d. 99%

e. 100%

18. What are the arithmetic and geometric average returns for a stock with annual returns of 21%, 8%,

-32%, 41%, and 5%?

a. 5.6%; 8.6%

b. 5.6%; 6.3%

c. 8.6%; 5.6%

d. 8.6%; 8.6%

e. 8.6%; 6.3%

19. A stock had the following prices and dividends. What is the geometric average return on this stock?

a. 3.2%

b. 3.4%

c. 3.6%

d. 3.8%

e. 4.0%

20. Excelsior shares are currently selling for $25 each. You bought 200 shares one year ago at $24 and

received dividend payments of $1.50 per share. What was your percentage capital gain this year?

a. 4.17%

b. 6.25%

c. 10.42%

e. 110.42%

17

d. 104.17%

21. The prices for IMB over the last 3 years are given below. Assuming no dividends were paid, what

was the 3-year holding period return? Given the following information: Year 1 return = 10%, Year 2

return = 15%, Year 3 return = 12%.

a. 12.3%

b. 13.9%

c. 15.8%

d. 41.7%

e. 46.5%

22. The return pattern on your favorite stock has been 5%, 8%, -12%, 15%, 21% over the last five years.

What has been your average return and holding period return over the last 5 years?

a. 4.5%; 6.5%

b. 7.4%; 38.9%

c. 7.4%; 7.76%

d. 7.4%; 76.73%

23. A portfolio is:

a. a group of assets, such as stocks and bonds, held as a collective unit by an investor.

b. the expected return on a risky asset.

c. the expected return on a collection of risky assets.

d. the variance of returns for a risky asset.

e. the standard deviation of returns for a collection of risky assets.

24. The percentage of a portfolio's total value invested in a particular asset is called that asset's:

a. portfolio return.

b. portfolio weight.

c. portfolio risk.

d. rate of return.

e. investment value.

25. Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk.

a. idiosyncratic

b. diversifiable

c. systematic

d. asset-specific

e. total

26. Risk that affects at most a small number of assets is called _____ risk.

a. portfolio

b. undiversifiable

c. market

d. unsystematic

e. total

27. The principle of diversification tells us that:

a. concentrating an investment in two or three large stocks will eliminate all of your risk.

b. concentrating an investment in three companies all within the same industry will greatly reduce

your overall risk.

c. spreading an investment across five diverse companies will not lower your overall risk at all.

d. spreading an investment across many diverse assets will eliminate all of the risk.

e. spreading an investment across many diverse assets will eliminate some of the risk.

28. The _____ tells us that the expected return on a risky asset depends only on that asset's

nondiversifiable risk.

a. Efficient Markets Hypothesis (EMH)

e. principle of diversification

29. The amount of systematic risk present in a particular risky asset, relative to the systematic risk

present in an average risky asset, is called the particular asset's:

a. beta coefficient.

b. reward-to-risk ratio.

18

c. total risk.

d. diversifiable risk.

e. Treynor index.

30. The beta of a security is calculated by:

a. dividing the covariance of the security with the market by the variance of the market.

b. dividing the correlation of the security with the market by the variance of the market.

c. dividing the variance of the market by the covariance of the security with the market.

d. dividing the variance of the market by the correlation of the security with the market.

e. None of the above.

31. When computing the expected return on a portfolio of stocks the portfolio weights are based on the:

a. number of shares owned in each stock.

b. price per share of each stock.

c. market value of the total shares held in each stock.

d. original amount invested in each stock.

e. cost per share of each stock held.

32. The standard deviation of a portfolio will tend to increase when:

a. a risky asset in the portfolio is replaced with U.S. Treasury bills.

b. one of two stocks related to the airline industry is replaced with a third stock that is unrelated to the

airline industry.

c. the portfolio concentration in a single cyclical industry increases.

d. the weights of the various diverse securities become more evenly distributed.

e. short-term bonds are replaced with Treasury Bills.

33. Which one of the following is an example of systematic risk?

a. the price of lumber declines sharply

b. airline pilots go on strike

c. the Federal Reserve increases interest rates

d. a hurricane hits a tourist destination

e. people become diet conscious and avoid fast food restaurants

34. The systematic risk of the market is measured by:

a. a beta of 1.0.

b. a beta of 0.0.

e. a variance of 1.0.

35. Unsystematic risk:

a. can be effectively eliminated through portfolio diversification.

b. is compensated for by the risk premium.

c. is measured by beta.

d. cannot be avoided if you wish to participate in the financial markets.

e. is related to the overall economy.

36. Which one of the following is an example of unsystematic risk?

a. the inflation rate increases unexpectedly

19

c. an oil tanker runs aground and spills its cargo

d. interest rates decline by one-half of one percent

e. the GDP rises by 2% more than anticipated

37. The primary purpose of portfolio diversification is to:

a. increase returns and risks.

38. 38. Which one of the following would indicate a portfolio is being effectively diversified?

a. an increase in the portfolio beta

b. a decrease in the portfolio beta

c. an increase in the portfolio rate of return

d. an increase in the portfolio standard deviation

e. a decrease in the portfolio standard deviation

39. The majority of the benefits from portfolio diversification can generally be achieved with just _____

diverse securities.

a. 3

b. 6

c. 30

d. 50

e. 75

40. Which one of the following measures is relevant to the systematic risk principle?

a. variance

b. alpha

c. standard deviation

d. theta

e. beta

1~5 ABCDD

6~10ACEDA

11~15 CEBBD

16~20 DBCBA

21~25 DBABC

26~30 DEBAA

31~35 CCCAA

36~40 CCECE

()

A. can be greater than the expected return on the best performing security in the portfolio.

B. can be less than the expected return on the worst performing security in the portfolio.

C. is independent of the performance of the overall economy.

D. is limited by the returns on the individual securities within the portfolio.

E. is an arithmetic average of the returns of the individual securities when the weights of those

securities are unequal.

20

A. will equal the variance of the most volatile stock in the portfolio.

B. may be less than the variance of the least risky stock in the portfolio.

C. must be equal to or greater than the variance of the least risky stock in the portfolio.

D. will be a weighted average of the variances of the individual securities in the portfolio.

E. will be an arithmetic average of the variances of the individual securities in the portfolio.

3. A security that is fairly priced will have a return _____ the Security Market Line.

A. below

B. on or below

C. on

D. on or above

E. above

4. The intercept point of the security market line is the rate of return which corresponds to:

A. the risk-free rate of return.

C. a value of zero.

D. a value of 1.0.

5. A stock with an actual return that lies above the security market line:

A. has more systematic risk than the overall market.

B. has more risk than warranted based on the realized rate of return.

C. has yielded a higher return than expected for the level of risk assumed.

D. has less systematic risk than the overall market.

E. has yielded a return equivalent to the level of risk assumed.

6. The market risk premium is computed by:

A. adding the risk-free rate of return to the inflation rate.

B. adding the risk-free rate of return to the market rate of return.

C. subtracting the risk-free rate of return from the inflation rate.

D. subtracting the risk-free rate of return from the market rate of return.

E. multiplying the risk-free rate of return by a beta of 1.0.

7. The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is

referred to as the:

A. market rate of return.

C. systematic return.

D. total return.

8. The efficient set of portfolios:

A. contains the portfolio combinations with the highest return for a given level of risk.

B. contains the portfolio combinations with the lowest risk for a given level of return.

C. is the lowest overall risk portfolio.

D. Both A and B.

E. Both A and C.

9. A well-diversified portfolio has negligible:

A. expected return.

B. systematic risk.

C. unsystematic risk.

D. variance.

21

E. Both C and D

10. The Capital Market Line is the pricing relationship between:

A. efficient portfolios and beta.

B. the risk-free asset and standard deviation of the portfolio return.

C. the optimal portfolio and the standard deviation of portfolio return.

D. beta and the standard deviation of portfolio return.

E. None of the above.

11. Beta measures:

A. the ability to diversify risk.

B. how an asset covaries with the market.

C. the actual return on an asset.

D. the standard deviation of the assets' returns.

E. All of the above.

12. The dominant portfolio with the lowest possible risk is:

A. the efficient frontier.

13. An efficient set of portfolios is:

A. the complete opportunity set.

B. the portion of the opportunity set below the minimum variance portfolio.

C. only the minimum variance portfolio.

D. the dominant portion of the opportunity set.

E. only the maximum return portfolio.

14. The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in:

A. the capital market line which shows that all investors will only invest in the riskless asset.

B. the capital market line which shows that all investors will invest in a combination of the riskless

asset and the tangency portfolio.

C. the security market line which shows that all investors will invest in the riskless asset only.

D. the security market line which shows that all investors will invest in a combination of the riskless

asset and the tangency portfolio.

E. None of the above.

15. According to the Capital Asset Pricing Model:

A. the expected return on a security is negatively and non-linearly related to the security's beta.

B. the expected return on a security is negatively and linearly related to the security's beta.

C. the expected return on a security is positively and linearly related to the security's variance.

D. the expected return on a security is positively and non-linearly related to the security's beta.

E. the expected return on a security is positively and linearly related to the security's beta

16. The diversification effect of a portfolio of two stocks:

A. increases as the correlation between the stocks declines.

22

C. decreases as the correlation between the stocks rises.

D. Both A and C.

E. None of the above.

17. The separation principle states that an investor will:

A. choose any efficient portfolio and invest some amount in the riskless asset to generate the expected

return.

B. choose an efficient portfolio based on individual risk tolerance or utility.

C. never choose to invest in the riskless asset because the expected return on the riskless asset is lower

over time.

D. invest only in the riskless asset and tangency portfolio choosing the weights based on individual

risk tolerance.

E. All of the above.

18. When a security is added to a portfolio the appropriate return and risk contributions are:

A. the expected return of the asset and its standard deviation.

B. the expected return and the variance.

C. the expected return and the beta.

D. the historical return and the beta.

E. these both can not be measured.

19. The correlation between stocks A and B is the:

A. covariance between A and B divided by the standard deviation of A times the standard deviation of

B.

B. standard deviation A divided by the standard deviation of B.

C. standard deviation of B divided by the covariance between A and B.

D. variance of A plus the variance of B dividend by the covariance.

E. None of the above.

20. You have a portfolio of two risky stocks which turns out to have no diversification benefit. The reason

you have no diversification is the returns:

A. are too small.

21. If the correlation between two stocks is +1, then a portfolio combining these two stocks will have a

variance that is:

A. less than the weighted average of the two individual variances.

B. greater than the weighted average of the two individual variances.

C. equal to the weighted average of the two individual variances.

D. less than or equal to average variance of the two weighted variances, depending on other

information.

E. None of the above.

23

22. The total number of variance and covariance terms in a portfolio is N2. How many of these would be

(including non-unique) covariances?

A. N

B. N2

C. N2- N

D. N2- N/2

23. You want your portfolio beta to be 1.20. Currently, your portfolio consists of $100 invested in stock A

with a beta of 1.4 and $300 in stock B with a beta of .6. You have another $400 to invest and want to

divide it between an asset with a beta of 1.6 and a risk-free asset. How much should you invest in the

risk-free asset?

A. $0

B. $140

C. $200

D. $320

E. $400

24. You are comparing stock A to stock B. Given the following information, which one of these two

stocks should you prefer and why?

B. Stock A; because it has a higher expected return and appears to be less risky than stock B.

C. Stock A; because it has a slightly lower expected return but appears to be significantly less risky

than stock B.

D. Stock B; because it has a higher expected return and appears to be just slightly more risky than

stock A.

E. Stock B; because it has a higher expected return and appears to be less risky than stock A.

25. Zelo, Inc. stock has a beta of 1.23. The risk-free rate of return is 4.5% and the market rate of return is

10%. What is the amount of the risk premium on Zelo stock?

A. 4.47%

B. 5.50%

C. 5.54%

D. 6.77%

C. 9.78%

D. 10.59%

E. 12.30%

26. What is the expected return on this portfolio?

A. 9.50%

B. 9.67%

E. 10.87%

27. Your portfolio has a beta of 1.18. The portfolio consists of 15% U.S. Treasury bills, 30% in stock A,

and 55% in stock B. Stock A has a risk-level equivalent to that of the overall market. What is the beta

of stock B?

A. .55

B. 1.10

C. 1.24

E. 1.60

24

D. 1.40

28. The risk-free rate of return is 4% and the market risk premium is 8%. What is the expected rate of

return on a stock with a beta of 1.28?

A. 9.12%

B. 10.24%

C. 13.12%

D. 14.24%

E. 15.36%

29. The stock of Big Joe's has a beta of 1.14 and an expected return of 11.6%. The risk-free rate of return

is 4%. What is the expected return on the market?

A. 7.60%

B. 8.04%

C. 9.33%

D. 10.67%

E. 12.16%

30. The stock of Martin Industries has a beta of 1.43. The risk-free rate of return is 3.6% and the market

risk premium is 9%. What is the expected rate of return on Martin Industries stock?

A. 11.3%

B. 14.1%

C. 16.5%

D. 17.4%

E. 18.0%

31. Which one of the following stocks is correctly priced if the risk-free rate of return is 2.5% and the

market risk premium is 8%?

A. A

B. B

C. C

D. D

E. E

32. The variance of Stock A is .004, the variance of the market is .007 and the covariance between the two

is .0026. What is the correlation coefficient?

A. .9285

B. .8542

C. .5010

D. .4913

E. .3510

33. A portfolio has 50% of its funds invested in Security One and 50% of its funds invested in Security

Two. Security One has a standard deviation of 6%. Security Two has a standard deviation of 12%. The

securities have a coefficient of correlation of 0.5. Which of the following values is closest to portfolio

variance?

A. .0027

B. .0063

C. .0095

D. .0104

34. A portfolio has 25% of its funds invested in Security C and 75% of its funds invested in Security D.

Security C has an expected return of 8% and a standard deviation of 6%. Security D has an expected

return of 10% and a standard deviation of 10%. The securities have a coefficient of correlation of 0.6.

Which of the following values is closest to portfolio return and variance?

A. .090; .0081

B. .095; .001675

C. .095; .0072

35. In the equation R =

25

D. .100; .00849

C. actual total return, expected return, and unexpected return.

D. required return, expected return, and unbiased risk.

E. risk, expected return, and unsystematic risk.

36. Systematic risk is defined as:

A. a risk that specifically affects an asset or small group of assets.

B. any risk that affects a large number of assets.

C. any risk that has a huge impact on the return of a security.

D. the random component of return.

E. None of the above.

37. A company owning gold mines will probably have a _____ inflation beta because an ___ increase in

inflation is usually associated with an increase in gold prices.

A. negative; anticipated

B. positive; anticipated

C. negative; unanticipated

D. positive; unanticipated

38. If company A, a medical research company, makes a new product discovery and their stock rises 5%,

this will have:

A. no effect on Company B's, a newspaper, stock price because it is a systematic risk element.

B. no effect on Company B's, a newspaper, stock price because it is an unsystematic risk element.

C. a large effect on Company B's, a newspaper, stock price because it is a systematic risk element.

D. a large effect on Company B's, a newspaper, stock price because it is an unsystematic risk element.

E. None of the above.

39. A criticism of the CAPM is that it:

A. ignores the return on the market portfolio.

B. ignores the risk-free return.

C. requires a single measure of systematic risk.

D. utilizes too many factors.

E. None of the above.

40. An advantage of the APT over CAPM is:

A. APT can handle multiple factors.

B. if the factors can be properly identified, the APT may have more explanation/predictive power for

returns.

C. the APT forces unsystematic risk to be negative to offset systematic risk; thus making the total

portfolio risk free, allowing for an arbitrage opportunity for the astute investor.

D. Both A and B.

E. All of the above.

1~5 DBCAC

21~25 CCABD

6~10 DBDCC

26~30 DEDDC

11~15 BBDBE

31~35 BDBCC

26

16~20 DDCAD

36~40 BDBCD

()

1. A financial contract that gives its owner the right, but not the obligation, to buy or sell a specified

asset at an agreed-upon price on or before a given future date is called a(n) _____ contract.

A. option

B. futures

C. forward

D. swap

E. straddle

2. The act where an owner of an option buys or sells the underlying asset, as is his right, is called

______ the option.

A. striking

B. exercising

C. opening

D. splitting

E. strangling

3. The fixed price in an option contract at which the owner can buy or sell the underlying asset is called

the option's:

A. opening price.

B. intrinsic value.

C. strike price.

D. market price.

E. time value.

4. The last day on which an owner of an option can elect to exercise is the _____ date.

A. ex-payment

B. ex-option

C. opening

D. expiration

E. intrinsic

5. An option that may be exercised at any time up to its expiration date is called a(n) _____ option.

A. futures

B. Asian

C. Bermudan

D. European

E. American

6. An option that may be exercised only on the expiration date is called a(n) _____ option.

A. European

B. American

C. Bermudan

D. futures

E. Asian

7. A trading opportunity that offers a riskless profit is called a(n):

A. put option.

B. call option.

C. market equilibrium.

D. arbitrage.

E. cross-hedge.

8. The value of an option if it were to immediately expire, that is, its lower pricing bound, is called an

option's _____ value.

A. strike

B. market

C. volatility

D. time

E. intrinsic

9. An option that grants the right, but not the obligation, to sell shares of the underlying asset on a

particular date at a specified price is called:

A. either an American or a European option.

B. an American call.

C. an American put.

D. European put.

E. European call.

27

10. Which one of the following provides the option of selling a stock anytime during the option period at

a specified price even if the market price of the stock declines to zero?

A. American call

B. European call

C. American put

D. European put

11. Which one of the following statements correctly describes your situation as the owner of an American

call option?

A. You are obligated to buy at a set price at any time up to and including the expiration date.

B. You have the right to sell at a set price at any time up to and including the expiration date.

C. You have the right to buy at a set price only on the expiration date.

D. You are obligated to sell at a set price if the option is exercised.

E. You have the right to buy at a set price at any time up to and including the expiration date.

12. 12. Jeff opted to exercise his August option on August 10 and received $2,500 in exchange for his

shares. Jeff must have owned a (an):

A. warrant.

B. American call.

C. American put.

D. European call.

E. European put.

13. Jillian owns an option which gives her the right to purchase shares of WAN stock at a price of $20 a

share. Currently, WAN stock is selling for $24.50. Jillian would like to profit on this stock but is not

permitted to exercise her option for another two weeks.

Which of the following statements apply to this situation?

I. Jillian must own a European call option.

II. Jillian must own an American put option.

III. Jillian should sell her option today if she feels the price of WAN stock will decline significantly

over the next two weeks.

IV. Jillian cannot profit today from the price increase in WAN stock.

A. I and III only

B. II and IV only

C. I and IV only

14. If a call has a positive intrinsic value at expiration the call is said to be:

A. funded.

B. unfunded.

C. at the money.

D. in the money.

15. A put option with a $35 exercise price on ABC stock expires today. The current price of ABC stock is

$36. The put is:

A. funded.

B. unfunded.

C. at the money.

D. in the money.

16. The intrinsic value of a call is:

I. the value of the call if it were about to expire.

II. equal to the lower bound of a call's value.

III. another name for the market price of a call.

IV. always equal to zero if the call is currently out of the money.

A. I and III only

B. II and IV only

C. I and II only

28

17. The intrinsic value of a put is equal to the:

A. lesser of the strike price or the stock price.

B. lesser of the stock price minus the exercise price or zero.

C. lesser of the stock price or zero.

D. greater of the strike price minus the stock price or zero.

E. greater of the stock price minus the exercise price or zero.

18. You own stock in a firm that has a pure discount loan due in six months. The loan has a face value of

$50,000. The assets of the firm are currently worth $62,000. The stockholders in this firm basically

own a _____ option on the assets of the firm with a strike price of ______

A. put; $62,000.

B. put; $50,000.

C. warrant; $62,000.

D. call; $62,000.

E. call; $50,000.

19. The owner of a call option has the:

A. right but not the obligation to buy a stock at a specified price on a specified date.

B. right but not the obligation to buy a stock at a specified price during a specified period of time.

C. obligation to buy a stock on a specified date but only at the specified price.

D. obligation to buy a stock sometime during a specified period of time at the specified price.

E. obligation to buy a stock at the lower of the exercise price or the market price on the expiration

date.

20. If you consider the equity of a firm to be an option on the firm's assets then the act of paying off debt

is comparable to _____ on the assets of the firm.

A. purchasing a put option

21. Which of the following statements is true?

A. American options are options on securities of U.S. corporations, and the options are traded on

American exchanges. European options are options on securities of U.S. corporations, but the

options are traded on European exchanges.

B. American options are options on securities which are traded on American exchanges. European

options, also traded on American exchanges, are options on European corporations.

C. American options give the holder the right to the dividend payment. European options do not.

D. American options may be exercised anytime up to expiration. European options may be exercised

only at expiration.

E. None of the above.

22. An out-of-the-money call option is one that:

A. has an exercise price below the current market price of the underlying security.

B. should not be exercised.

C. has an exercise price above the current market price of the underlying security.

D. Both A and B.

E. Both B and C.

29

23. Which of the following is not true concerning call option writers?

A. Writers promise to deliver shares if exercised by the buyer.

B. The writer has the option to sell shares but not an obligation.

C. The writer's liability is zero if the option expires out-of-the-money.

D. The writer receives a cash payment from the buyer at the time the option is purchased.

E. The writer has a loss if the market price rises substantially above the exercise price.

24. An in-the-money put option is one that:

A. has an exercise price greater than the underlying stock price.

B. has an exercise price less than the underlying stock price.

C. has an exercise price equal to the underlying stock price.

D. should not be exercised at expiration.

E. should not be exercised at any time.

25. Which of the following statements is true?

A. At expiration the maximum price of a call is the greater of (Stock Price - Exercise) or 0.

B. At expiration the maximum price of a call is the greater of (Exercise - Stock Price) or 0.

C. At expiration the maximum price of a put is the greater of (Stock Price - Exercise) or 0.

D. At expiration the maximum price of a put is the greater of (Exercise - Stock Price) or 0.

E. Both A and D.

26. You purchased six TJH call option contracts with a strike price of $40 when the option was quoted at

$1.30. The option expires today when the value of TJH stock is $41.90. Ignoring trading costs and

taxes, what is your total profit or loss on your investment?

A. $60

B. $320

C. $360

D. $420

E. $540

27. 27. You purchased four WXO 30 call option contracts at a quoted price of $.34. What is your net gain

or loss on this investment if the price of WXO is $33.60 on the option expiration date?

A. -$1,576

B. -$136

C. $1,304

D. $1,440

E. $1,576

28. A derivative is a financial instrument whose value is determined by:

A. a regulatory body such as the FTC.

C. hedging a risk.

D. hedging a speculation.

29. Derivatives can be used to either hedge or speculate. These actions:

A. increase risk in both cases.

B. decrease risk in both cases.

C. spread or minimize risk in both cases.

D. offset risk by hedging and increase risk by speculating.

E. offset risks by speculating and increase risk by hedging.

30

A. agreeing today to buy a product at a later date at a price to be set in the future.

B. agreeing today to buy a product today at its current price.

C. agreeing today to buy a product at a later date at a price set today.

D. agreeing today to buy a product if and only if its price rises above the exercise price today at its

current price.

E. None of the above.

31. The buyer of a forward contract:

A. will be taking delivery of the good(s) today at today's price.

B. will be making delivery of the good(s) at a later date at that date's price.

C. will be making delivery of the good(s) today at today's price.

D. will be taking delivery of the good(s) at a later date at pre-specified price.

E. Both A or D.

32. The main difference between a forward contract and a cash transaction is:

A. only the cash transaction creates an obligation to perform.

B. a forward is performed at a later date while the cash transaction is performed immediately.

C. only one involves a deliverable instrument.

D. neither allows for hedging.

E. None of the above.

33. Futures contracts contrast with forward contracts by:

A. trading on an organized exchange.

B. marking to the market on a daily basis.

C. allowing the seller to deliver any day over the delivery month.

D. All of the above.

E. None of the above.

34. Which of the following terms is not part of a forward contract?

A. Making delivery

B. Taking delivery

C. Delivery instrument

D. Cash transaction

35. A futures contract on gold states that buyers and sellers agree to make or take delivery of an ounce of

gold for $400 per ounce. The contract expires in 3 months. The current price of gold is $400 per

ounce. If the price of gold rises and continues to rise every day over the 3 month period, then when

the contract is settled, the buyer will _____ and the seller will _____.

A. lose; gain

B. gain; lose

D. gain; gain

E. lose; lose

36. A potential disadvantage of forward contracts versus futures contracts is:

A. the extra liquidity required to cover the potential outflows that occur prior to delivery and caused

by marking to market.

B. the incentive for a particular party to default.

31

C. that the buyers and sellers don't know each other and never meet.

D. All of the above.

E. Both A and C.

37. A farmer with wheat in the fields and who uses the futures market to protect a profit is an example of:

A. a long hedge.

B. a short hedge.

C. selling futures to guard against a potential loss.

D. Both A and C.

E. Both B and C.

38. A miller who needs wheat to mill to flour uses the futures market to protect a profit by:

A. a long hedge to take delivery.

B. a short hedge to deliver.

C. buying futures to guard against a potential loss.

D. Both A and C.

E. Both B and C.

39. A chocolate company which uses the futures market to lock in the price of cocoa to protect a profit is

an example of:

A. a long hedge.

B. a short hedge.

C. purchasing futures to guard against a potential loss.

D. Both A and C.

E. Both B and C.

40. If the producer of a product has entered into a fixed price sale agreement for that output, the producer

faces:

A. a nice steady profit because the output price is fixed.

B. an uncertain profit if the input prices are volatile. This risk can be reduced by a short hedge.

C. an uncertain profit if the input prices are volatile. This risk can be reduced by a long hedge.

D. a modest profit if the input prices are stable. This risk can be reduced by a long hedge.

E. a modest profit if the input prices are stable. This risk can be reduced by a short hedge.

1~5 ABCDE

21~25 DEBAE

6~10 ADEDC

11~15 ECADE

16~20 EDEAD

26~30 CCBDC

31~35 DBBDB

36~40 BEDDC

32

CH7

1.

The ability of shareholders to undo the dividend policy of the firm and create an alternative dividend

payment policy via reinvesting dividends or selling shares of stock is called (a):

A. perfect foresight model.

B. MM Proposition I.

D. homemade leverage.

E. homemade dividends.

2.

The market's reaction to the announcement of a change in the firm's dividend payout is likely the:

A. information content effect.

B. clientele effect.

D. MM Proposition I.

E. MM Proposition II.

3.

The observed empirical fact that stocks attract particular investors based on the firm's dividend policy

and the resulting tax impact on investors is called the:

A. information content effect.

B. clientele effect.

D. MM Proposition I.

E. MM Proposition II.

4.

A _____ is an alternative method to cash dividends which is used to pay out a firm's earnings to

shareholders.

A. merger

B. acquisition

C. payment-in-kind

D. stock split

E. share repurchase

5.

A payment made by a firm to its owners in the form of new shares of stock is called a _____

dividend.

A. stock

B. normal

C. special

D. extra

E. liquidating

6.

An increase in a firm's number of shares outstanding without any change in owners' equity is called

a:

A. special dividend.

B. stock split.

C. share repurchase.

D. tender offer.

E. liquidating dividend.

7.

A. the number of shares outstanding increases and owners' equity decreases.

B. the firm buys back existing shares of stock on the open market.

C. the firm sells new shares of stock on the open market.

D. the number of shares outstanding decreases but owners' equity is unchanged.

E. shareholders make a cash payment to the firm.

8.

A. the tax on capital gains is deferred until the gain is realized

B. few, if any, positive net present value projects are available to the firm

C. a preponderance of stockholders have minimal taxable income

D. a majority of stockholders have other investment opportunities that offer higher rewards with

33

E. corporate tax rates exceed personal tax rates

9.

I. a state law restricting dividends in excess of retained earnings

II. a term contained in bond indenture agreements

III. the desire to maintain constant dividends over time

IV. flotation costs

A. II and III only

B. I and IV only

10. Ignoring capital gains as an alternative, the tax law changes in 2003 tend to favor a:

A. lower dividend policy.

C. zero-dividend policy.

11. Which of the following are factors that favor a high dividend policy?

I. stockholders desire for current income

II. tendency for higher stock prices for high dividend paying firms

III. investor dislike of uncertainty

IV. high percentage of tax-exempt institutional stockholders

A. I and III only

B. II and IV only

12. The information content of a dividend increase generally signals that:

A. the firm has a one-time surplus of cash.

B. the firm has few, if any, net present value projects to pursue.

C. management believes that the future earnings of the firm will be strong.

D. the firm has more cash than it needs due to sales declines.

E. future dividends will be lower.

1~5 EABEA

6~10 BDAED

11~12 EC

34

()

)

CH1+CH8

CH1+CH8

1.

Warrants are similar to options, in that the value of the warrant is limited by:

A. expiring worthless if the stock price is below the total warrant exercise price.

B. the trading capabilities of the exchange used.

C. the price of the underlying stock divided by the number of warrants needed to purchase a share.

D. Both A and C.

E. Both B and C.

2.

Which of the following would not describe the difference between warrants and call options?

A. Warrants are issued by firms whereas call options are issued by individuals.

B. Call options have an exercise price whereas warrants do not.

C. Exercising of warrants creates dilution whereas exercising call options does not.

D. When call options are exercised existing shares trade hands whereas if warrants are exercised new

stock must be issued.

E. None of the above.

3.

A. warrants are contracts outside of the firm while options are within the firm.

B. warrants have long maturities while options are usually short maturities.

C. warrant exercise dilutes the value of equity while option exercise does not.

D. Both A and C.

E. Both B and C.

4.

A. a 3 for 1 stock split

B. a large stock dividend of 20%

C. a large cash dividend

D. listing of the warrants on the NYSE

E. None of the above would harm the warrant holders.

5.

A. increases the total number of shares but does not affect share value.

B. increases the total number of shares which can reduce an individual share value.

C. does not change the number of shares outstanding, similar to options.

D. increases share value because cash is paid into the firm at the time of warrant exercise.

E. None of the above.

6.

If a corporate security can be exchanged for a fixed number of shares of stock, the security is said to

be:

A. callable.

B. convertible.

C. protected.

D. putable.

7.

The holder of a $1,000 face value bond has the right to exchange the bond anytime before maturity

for shares of stock priced at $50 per share. The $50 is called the:

A. conversion price.

B. stated price.

C. exercise price.

35

D. striking price.

8.

A. The value of a convertible bond will generally be greater than its straight bond value.

B. The value of a convertible bond will generally be greater than its conversion value.

C. The difference between the conversion value and the straight bond value is the conversion or

option premium.

D. The coupon rate on a nonconvertible bond will generally exceed the coupon rate on an otherwise

identical convertible bond.

E. All of the above are correct.

9.

A. A convertible bond issue would generally have fewer restrictive covenants than an otherwise

identical nonconvertible bond.

B. Convertible bonds can be issued at a lower coupon compared with otherwise non-convertible

bonds.

C. If the value of a convertible bond exceeds the maximum of its straight bond value or its

conversion value, the difference would be referred to as the option value.

D. Since convertible bonds will be exchanged for common stock, convertible bonds are generally not

callable.

E. More than one of the above is incorrect.

10. Concerning convertible bonds, which of the following statements is not correct?

A. With regard to security, most convertible bonds are secured by common stock (i.e., they are

collateral trust bonds).

B. For most convertible bonds, the issuing firm can, under certain circumstances, effectively force

bondholders to convert to common stock.

C. When a convertible bond is called, the owner has the option of receiving cash or stock for the

bond.

D. All of the above are incorrect.

E. All of the above are correct.

1-5 DBECB

6-10 BACDA

()

)

CH9

1.

I. Being acquired by another firm is an effective method of replacing senior management.

II. The net present value of an acquisition should have no bearing on whether or not the acquisition

occurs.

III. Acquisitions are often relatively complex from an accounting and tax point of view.

IV. The value of a strategic fit is easy to estimate using discounted cash flow analysis.

36

B. II and IV only

C. I and IV only

2.

In a merger the:

A. legal status of both the acquiring firm and the target firm is terminated.

B. acquiring firm retains its name and legal status.

C. acquiring firm acquires the assets but not the liabilities of the target firm.

D. stockholders of the target firm have little, if any, say as to whether or not the merger occurs.

E. target firm always continues to exist as a subsidiary of the acquiring firm.

3.

If Microsoft were to acquire U.S. Airways, the acquisition would be classified as a _____

acquisition.

A. horizontal

B. longitudinal

C. conglomerate

D. vertical

E. complementary resources

4.

I. increasing the market power of the combined firm.

II. improving the distribution network of the acquiring firm.

III. providing the combined firm with a strategic advantage.

IV. reducing the utilization of the acquiring firm's assets.

A. I and III only

C. I and IV only

5.

I. a reduction in the level of debt

A. I and IV only

6.

Rudy's, Inc. and Blackstone, Inc. are all-equity firms. Rudy's has 1,500 shares outstanding at a

market price of $22 a share. Blackstone has 2,500 shares outstanding at a price of $38 a share.

Blackstone is acquiring Rudy's for $36,000 in cash. What is the merger premium per share?

A. $2.00

B. $4.25

C. $6.50

D. $8.00

E. $14.00

7.

Jennifer's Boutique has 2,100 shares outstanding at a market price per share of $26. Sally's has 3,000

shares outstanding at a market price of $41 a share. Neither firm has any debt. Sally's is acquiring

Jennifer's for $58,000 in cash. The incremental value of the acquisition is $2,500. What is the value

of Jennifer's Boutique to Sally's?

A. $26,000

B. $27,600

C. $57,100

D. $58,200

E. $60,500

8.

ABC and XYZ are all-equity firms. ABC has 1,750 shares outstanding at a market price of $20 a

share. XYZ has 2,500 shares outstanding at a price of $28 a share. XYZ is acquiring ABC for

$36,000 in cash. The incremental value of the acquisition is $3,000. What is the net present value of

37

A. $1,000

B. $2,000

C. $3,000

D. $4,000

E. $5,000

9.

Winslow Co. has agreed to be acquired by Ferrier, Inc. for $25,000 worth of Ferrier stock. Ferrier

currently has 1,500 shares of stock outstanding at a price of $21 a share. Winslow has 1,000 shares

outstanding at a price of $22. The incremental value of the acquisition is $4,000. What is the merger

premium per share?

A. $1

B. $2

C. $3

D. $4

E. $569.

10. The Sligo Co. is planning on merging with the Thorton Co. Sligo will pay Thorton's stockholders the

current value of their stock in shares of Sligo. Sligo currently has 2,300 shares of stock outstanding at

a market price of $20 a share. Thorton has 1,800 shares outstanding at a price of $15 a share. How

many shares of stock will be outstanding in the merged firm?

A. 1,800 shares

B. 2,300 shares

C. 2,750 shares

E. 4,100 shares

38

D. 3,650 shares

The exam will have 25 multiple choice questions and 5 work problems

You are not responsible for any topics that are not covered in the lecture note

slides (lecture 5, 6, 7, 8).

Questions in the multiple choice section will be either concept or calculation

questions. The calculation questions will be similar to those in the homework and

review. However, the concept questions will be related to any topic we have

covered in the class. The concept questions in the review are only some sample

questions. You should NOT study only topics in the review.

For the work problems, you need to solve the problems without knowing the

possible answers. The questions will be similar to those in the homework and the

review except that the possible solutions are not given.

You can bring a formula sheet to the exam.

Chapter 5&6

1. Of the alternatives available, __________ typically have the highest standard deviation

of returns.

A) commercial paper

B) corporate bonds

C) stocks

D) treasury bills

2. The holding period return on a stock is equal to __________.

A) the capital gain yield over the period plus the inflation rate

B) the capital gain yield over the period plus the dividend yield

C) the current yield plus the dividend yield

D) the dividend yield plus the risk premium

3. .Suppose you pay $9,800 for a Treasury bill maturing in two months. What is the

annual percentage rate of return for this investment? Assume par value = $10,000

A) 2%

B) 12%

C) 12.2%

D) 16.4%

4. The market risk premium is defined as ___________.

A) the difference between the return on an index fund and the return on Treasury

bills

B) the difference between the return on a small firm mutual fund and the return

on the Standard and Poor's 500 index

C) the difference between the return on the risky asset with the lowest returns

and the return on Treasury bills

D) the difference between the return on the highest yielding asset and the lowest

yielding asset.

5. The reward/variability ratio is given by __________.

A) the slope of the capital allocation line

B) the second derivative of the capital allocation line

C) the point at which the second derivative of the investor's indifference curve

reaches zero

D) none of the above

6. A Treasury bill pays a 6% rate of return. A risk averse investor __________ invest in

a risky portfolio that pays 12% with a probability of 40% or 2% with a probability

of 60% because __________.

A) might; she is rewarded a risk premium

B) would not; because she is not rewarded any risk premium

C) would not; because the risk premium is small

D) cannot be determined

7. The holding period return on a stock was 30%. Its ending price was $26 and its cash

dividend was $1.50. Its beginning price must have been __________.

A) $20.00

B) $21.15

C) $86.67

D) $91.67

8. You have $500,000 available to invest. The risk-free rate as well as your borrowing

rate is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22%

return, you should __________.

A) invest $125,000 in the risk-free asset

B) invest $375,000 in the risk-free asset

C) borrow $125,000

D) borrow $375,000

9. The price of a stock is $55 at the beginning of the year and $53 at the end of the year.

If the stock paid a $3 dividend what is the holding period return for the year?

A) 1.82%

B) 3.64%

C) 5.45%

D) 10.0%

10. Elias is a risk-averse investor. David is a less risk-averse investor than Elias.

Therefore,

A. for the same risk, David requires a higher rate of return than Elias.

B. for the same return, Elias tolerates higher risk than David.

C. for the same risk, Elias requires a lower rate of return than David.

D. for the same return, David tolerates higher risk than Elias.

E. cannot be determined.

11. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15.

The risk-free rate is 6 percent. An investor has the following utility function: U = E(r) (A/2)s2. Which value of A makes this investor indifferent between the risky portfolio and

the risk-free asset?

A. 5

B. 6

C. 7

D. 8

E. none of the above

12. Based on the utility function above, which investment would you select?

A. 1

B. 2

C. 3

D. 4

E. cannot tell from the information given

13. Which investment would you select if you were risk neutral?

A. 1

B. 2

C. 3

D. 4

E. cannot tell from the information given

14. The presence of risk means that

A. investors will lose money.

B. more than one outcome is possible.

C. the standard deviation of the payoff is larger than its expected value.

D. final wealth will be greater than initial wealth.

E. terminal wealth will be less than initial wealth.

A. investment opportunity set formed with a risky asset and a risk-free asset.

B. investment opportunity set formed with two risky assets.

C. line on which lie all portfolios that offer the same utility to a particular investor.

D. line on which lie all portfolios with the same expected rate of return and different

standard deviations.

E. none of the above.

16. An investor invests 30 percent of his wealth in a risky asset with an expected rate of

return of 0.15 and a variance of 0.04 and 70 percent in a T-bill that pays 6 percent. His

portfolio's expected return and standard deviation are __________ and __________,

respectively.

A. 0.114; 0.12

B. 0.087;0.06

C. 0.295; 0.12

D. 0.087; 0.12

E. none of the above

17. What percentages of your money must be invested in the risky asset and the risk-free

asset, respectively, to form a portfolio with an expected return of 0.11?

A. 53.8% and 46.2%

B. 75% and 25%

C. 62.5% and 37.5%

D. 46.1% and 53.8%

E. Cannot be determined.

18. What percentages of your money must be invested in the risk-free asset and the risky

asset, respectively, to form a portfolio with a standard deviation of 0.20?

A. 30% and 70%

B. 50% and 50%

C. 60% and 40%

D. 40% and 60%

E. Cannot be determined.

Chapter 7&8

19. Risk that can be eliminated through diversification is called ______ risk.

A) unique

B) firm-specific

C) diversifiable

D) all of the above

20. The _______ decision should take precedence over the _____ decision.

A) asset allocation, stock selection

B) choice of fad, mutual fund selection

C) stock selection, asset allocation

D) stock selection, mutual fund selection

21.

A) beta

B) firm specific risk

C) market risk

D) systematic risk

22.

A) The higher the coefficient of correlation between securities, the greater will be

the reduction in the portfolio variance

B) There is a direct relationship between the securities coefficient of correlation

and the portfolio variance

C) The degree to which the portfolio variance is reduced depends on the degree

of correlation between securities

D) none of the above

23.

risky asset _________________.

A) will always end up on the efficient frontier

B) will always end up on the efficient frontier or within the efficient frontier, but

never outside the efficient frontier

C) will always end up within the efficient frontier

D) may end up anywhere in expected return-standard deviation space

24.

A) the minimum variance point on the efficient frontier

B) the maximum return point on the efficient frontier

C) the tangency point of the capital market line and the efficient frontier

D) None of the above answers is correct

25.

of return of 25% while stock B has a standard deviation of return of 5%. Stock A

comprises 20% of the portfolio while stock B comprises 80% of the portfolio. If

the variance of return on the portfolio is .0050, the correlation coefficient between

the returns on A and B is __________.

A) -.225

B) -.474

C) .474

D) .225

26.

A) beta

B) standard deviation

C) covariance

D) semi-variance

27.

________ at a _________ rate.

A) rise; decreasing

B) rise; increasing

C) fall; decreasing

D) fall; increasing

28.

A) the trend line representing the security's tendency to advance or decline in the

market over some period of time

B) the "best fit" line representing the regression of the security's excess returns

on market excess returns over some period of time

C) another term for the capital allocation line representing the set of complete

portfolios that can be constructed by combining the security with T-bill

holdings

D) None of the above answers is correct

29.

A) its returns are negatively correlated with market index returns

B) its returns are positively correlated with market index returns

C) its stock price has historically been very stable

D) market demand for the firm's shares is very low

30.

diversification benefit?

A) -0.6

B) -1.5

C) 0.0

D) 0.8

31.

What is the standard deviation of a portfolio of two stocks given the following

data? Stock A has a standard deviation of 22%. Stock B has a standard deviation

of 16%. The portfolio is equally weighted and the correlation coefficient between

the two stocks is .35.

A) 15.7%

B) 16.0%

C) 18.8%

D) 22.0%

32.

The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the

portfolio standard deviation is 12.0%, what is the reward to variability ratio of the

portfolio?

A) 0.0

B) 0.45

C) 0.74

D) 1.35

A. the portion of the investment opportunity set that lies above the global minimum

variance portfolio.

B. the portion of the investment opportunity set that represents the highest standard

deviations.

C. the portion of the investment opportunity set which includes the portfolios with the

lowest standard deviation.

D. the set of portfolios that have zero standard deviation.

E. both A and B are true.

34. The Capital Allocation Line provided by a risk-free security and N risky securities is

A. the line that connects the risk-free rate and the global minimum-variance portfolio of

the risky securities.

B. the line that connects the risk-free rate and the portfolio of the risky securities that has

the highest expected return on the efficient frontier.

C. the line tangent to the efficient frontier of risky securities drawn from the risk-free

rate.

D. the horizontal line drawn from the risk-free rate.

E. none of the above.

35. Which of the following statement(s) is (are) false regarding the selection of a

portfolio from those that lie on the Capital Allocation Line?

A. Less risk-averse investors will invest more in the risk-free security and less in the

optimal risky portfolio than more risk-averse investors.

B. More risk-averse investors will invest less in the optimal risky portfolio and more in

the risk-free security than less risk-averse investors.

C. Investors choose the portfolio that maximizes their expected utility.

D. A and B.

E. A and C.

36. An investor who wishes to form a portfolio that lies to the right of the optimal risky

portfolio on the Capital Allocation Line must:

A. lend some of her money at the risk-free rate and invest the remainder in the optimal

risky portfolio.

B. borrow some money at the risk-free rate and invest in the optimal risky portfolio.

C. invest only in risky securities.

D. such a portfolio cannot be formed.

E. B and C

37. Security X has expected return of 12% and standard deviation of 20%. Security Y has

expected return of 15% and standard deviation of 27%. If the two securities have a

correlation coefficient of 0.7, what is their covariance?

A. 0.038

B. 0.070

C. 0.018

D. 0.013

E. 0.054

38. The line representing all combinations of portfolio expected returns and standard

deviations that can be constructed from two available assets is called the

A. risk/reward tradeoff line

B. Capital Allocation Line

C. efficient frontier

D. portfolio opportunity set

E. Security Market Line

39. Given an optimal risky portfolio with expected return of 14% and standard deviation

of 22% and a risk free rate of 6%, what is the slope of the best feasible CAL?

A. 0.64

B. 0.14

C. 0.08

D. 0.33

E. 0.36

40. The standard deviation of a two-asset portfolio is a linear function of the assets'

weights when

A. the assets have a correlation coefficient less than zero.

B. the assets have a correlation coefficient equal to zero.

C. the assets have a correlation coefficient greater than zero.

D. the assets have a correlation coefficient equal to one.

E. the assets have a correlation coefficient less than one.

41. When borrowing and lending at a risk-free rate are allowed, which Capital Allocation

Line (CAL) should the investor choose to combine with the efficient frontier?

I) with the highest reward-to-variability ratio.

II) that will maximize his utility.

III) with the steepest slope.

IV) with the lowest slope.

A. I and III

B. I and IV

C. II and IV

D. I only

E. I, II, and III

42. The expected rates of return of stocks A and B are _____ and _____, respectively.

A. 13.2%; 9%.

B. 13%; 8.4%

C. 13.2%; 7.7%

D. 7.7%; 13.2%

E. none of the above

43. The standard deviations of stocks A and B are _____ and _____, respectively.

A. 1.56%; 1.99%

B. 2.45%; 1.68%

C. 3.22%; 2.01%

D. 1.54%; 1.11%

E. none of the above

44. The coefficient of correlation between A and B is

A. 0.474.

B. 0.612.

C. 0.583.

D. 1.206.

E. none of the above.

45. If you invest 35% of your money in A and 65% in B, what would be your portfolio's

expected rate of return and standard deviation?

A. 9.9%; 3%

B. 9.9%; 1.1%

C. 10%; 1.7%

D. 10%; 3%

E. none of the above

Chapter 9&10

46.

Consider the CAPM. The risk-free rate is 5% and the expected return on the

market is 15%. What is the beta on a stock with an expected return of 12%?

A) .5

B) .7

C) 1.2

D) 1.4

47.

theory.

A) Only the stock beta affects the stock price

B) Only the stock unique risk affects the stock price

C) Only the stock variance and beta affect the stock price

D) Several systematic factors affect the stock price

48.

A) -1.0

B) 0

C) 0.5

D) 1.0

49.

return is a function of __________.

A) market risk

B) unsystematic risk

C) unique risk

D) reinvestment risk

50.

According to the capital asset pricing model, the expected rate of return on any

security is equal to __________.

A) [(the risk-free rate) + (beta of the security)] x (market risk premium)

B) (the risk-free rate) + [(variance of the security's return) x (market risk

premium)]

C) (the risk-free rate) + [(security's beta) x (market risk premium)]

D) (market rate of return) + (the risk-free rate)

51.

According to the capital asset pricing model, fairly priced securities have

__________.

A) negative betas

B) positive alphas

C) positive betas

D) zero alphas

52.

The difference between a security's actual return and the return predicted by the

characteristic line associated with the security's past returns is ___________.

A) alpha

B) beta

C) gamma

D) residual

53.

A) A) the covariance between the security and market returns divided by the

variance of the market's returns

B) the covariance between the security and market returns divided by the

standard deviation of the market's returns

C) the variance of the security's returns divided by the covariance between the

security and market returns

D) the variance of the security's returns divided by the variance of the market's

returns

54.

Security A has an expected rate of return of 12% and a beta of 1.10. The market

expected rate of return is 8% and the risk-free rate is 5%. The alpha of the stock

is __________.

A) -1.7%

B) 3.7%

C) 5.5%

D) 8.7%

55.

The risk-free rate is 4%. The expected market rate of return is 11%. If you

expect stock X with a beta of .8 to offer a rate of return of 12 percent, then you

should __________.

A) buy stock X because it is overpriced

B) buy stock X because it is underpriced

C) sell short stock X because it is overpriced

D) sell short stock X because it is underpriced

56. According to capital asset pricing theory, the key determinant of portfolio returns is

__________.

A) the degree of diversification

B) the systematic risk of the portfolio

C) the firm specific risk of the portfolio

D) economic factors

57. Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%.

Portfolio X has an expected return of 14% and a beta of 1.00. Portfolio Y has an

expected return of 9.5% and a beta of 0.25. In this situation, you would conclude

that portfolios X and Y __________.

A) are in equilibrium

B) offer an arbitrage opportunity

C) are both underpriced

D) are both fairly priced

58. You hold a diversified portfolio consisting of a $5,000 investment in each of 20

different common stocks. The portfolio beta is equal to 1.12. You have decided to sell a

lead mining stock (b = 1.0) at $5,000 net and use the proceeds to buy a like amount of a

steel company stock (b = 2.0). What is the new beta of the portfolio?

a.

b.

c.

d.

e.

1.12

1.17

1.22

1.10

1.02

59. Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3.

The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the

Capital Asset Pricing Model, this security is

A. underpriced.

B. overpriced.

C. fairly priced.

D. cannot be determined from data provided.

E. none of the above.

60. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of

1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According

to the Capital Asset Pricing Model, this security is

A. underpriced.

B. overpriced.

C. fairly priced.

D. cannot be determined from data provided.

E. none of the above.

61. Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3.

The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the

Capital Asset Pricing Model, this security is

A. underpriced.

B. overpriced.

C. fairly priced.

D. cannot be determined from data provided.

E. none of the above.

62. As a financial analyst, you are tasked with evaluating a capital budgeting project. You

were instructed to use the IRR method and you need to determine an appropriate hurdle

rate. The risk-free rate is 4 percent and the expected market rate of return is 11 percent.

Your company has a beta of 1.4 and the project that you are evaluating is considered to

have risk equal to the average project that the company has accepted in the past.

According to CAPM, the appropriate hurdle rate would be ______%.

A. 13.8

B. 7

C. 15

D. 4

E. 1.4

Chapter 11

63.

The weak form EMH states that ________ must be reflected in the stock price.

A) all market trading data

B) all publicly available information

C) all information including inside information

D) none of the above

64.

A) a conservative investment strategy

B) a liberal investment strategy

C) a passive investment strategy

D) an aggressive investment strategy

65.

A) fundamental analysis

B) technical analysis

C) both a and b

D) neither a nor b

66.

__________ is the return on a stock beyond what would be predicted from market

movements alone.

A) a normal return

B) a subliminal return

C) an abnormal return

D) none of the above

67.

If you believe in the __________ form of the EMH, you believe that stock prices

reflect all information that can be derived by examining market trading data such

as the history of past stock prices, trading volume or short interest.

A) semi-strong

B) strong

C) weak

D) any of the above

68.

A) the small-firm January effect

B) the reversal effect

C) the book-to-market effect

D) All of the above have been considered market anomalies

69.

A) should focus on relative strength

B) should focus on resistance levels

C) should focus on support levels

D) are wasting their time

70.

When stock returns exhibit positive serial correlation, this means that __________

returns tend to follow ___________ returns.

A) positive; positive

B) positive ; negative

C) negative; positive

D) None of the above

71.

A) earned higher average returns than firms with low P/E ratios

B) earned the same average returns as firms with low P/E ratios

C) earned lower average returns than firms with low P/E ratios

D) had higher dividend yields than firms with low P/E ratios

72.

____________.

A) stock prices do not rapidly adjust to new information

B) future changes in stock prices cannot be predicted from any information that

is publicly available

C) corporate insiders should have no better investment performance than other

investors

D) arbitrage between futures and cash markets should not produce extraordinary

profits

73.

A) technical analysis, but supports fundamental analysis as valid

B) fundamental analysis, but supports technical analysis as valid

C) both fundamental analysis and technical analysis

D) technical analysis, but is silent on the possibility of successful fundamental

analysis

74. __________ focus more on past price movements of a firm's stock than on the

underlying determinants of future profitability.

A. Credit analysts

B. Fundamental analysts

C. Systems analysts

D. Technical analysts

E. All of the above

75. According to proponents of the efficient market hypothesis, the best strategy for a

small investor with a portfolio worth $40,000 is probably to

A. perform fundamental analysis.

B. exploit market anomalies.

C. invest in Treasury securities.

D. invest in derivative securities.

E. invest in mutual funds.

76. Google has a beta of 1.0. The annualized market return yesterday was 11%, and the

risk-free rate is currently 5%. You observe that Google had an annualized return

yesterday of 14%. Assuming that markets are efficient, this suggests that

A. bad news about Google was announced yesterday.

B. good news about Google was announced yesterday.

C. no news about Google was announced yesterday.

D. interest rates rose yesterday.

E. interest rates fell yesterday.

Answers

1. Answer: C

2. Answer: B

3. Answer: C

HPR =

10 ,000 9 ,800

= 2.04%

9 ,800

4. Answer: A

5. Answer: A

6. Answer: B

7. Answer: B

P=

8. Answer: D

y=

26.00 + 1.50

= 21.15

1 + .30

.22 .08

= 1.75

.16 .08

9. Answer: A

HPR = (53 55 +3) / 55 = .0182

10. D

The more risk averse the investor, the less risk that is tolerated, given a rate of return.

11. D

- 8/2(0.15)2 = 6%; U(Rf) = 6%.

12. C

13. D

If you are risk neutral, your only concern is with return, not risk.

14. B

The presence of risk means that more than one outcome is possible.

15. A

The CAL has an intercept equal to the risk-free rate. It is a straight line through the point

representing the risk-free asset and the risky portfolio, in expected-return/standard

deviation space.

16. B

17. A

1 - w1 = 0.461; 0.538(17%) + 0.462(4%) = 11.0%.

18. B

19. Answer: D

20. Answer: A

21. Answer: B

22. Answer: C

23. Answer: C

24. Answer: C

25. Answer: D

Corr = .225

26. Answer: B

27. Answer: C

28. Answer: B

29. Answer: A

30. Answer: D

31. Answer: A

32. Answer: B

Reward to variability ratio = (.089 - .035) / .12 = 0.45

33. A

Portfolios on the efficient frontier are those providing the greatest expected return for a

given amount of risk. Only those portfolios above the global minimum variance portfolio

meet this criterion.

34. C

The Capital Allocation Line represents the most efficient combinations of the risk-free

asset and risky securities. Only C meets that definition.

35. A

All rational investors select the portfolio that maximizes their expected utility; for

investors who are relatively more risk-averse, doing so means investing less in the

optimal risky portfolio and more in the risk-free asset.

36. E

The only way that an investor can create portfolios to the right of the Capital Allocation

Line is to create a borrowing portfolio (buy stocks on margin). In this case, the investor

will not hold any of the risk-free security, but will hold only risky securities.

37. A

38. D

The portfolio opportunity set is the line describing all combinations of expected returns

and standard deviations that can be achieved by a portfolio of risky assets.

39. E

40. D

When there is a perfect positive correlation (or a perfect negative correlation), the

equation for the portfolio variance simplifies to a perfect square. The result is that the

portfolio's standard deviation is linear relative to the assets' weights in the portfolio.

41. E

The optimal CAL is the one that is tangent to the efficient frontier. This CAL offers the

highest reward-to-variability ratio, which is the slope of the CAL. It will also allow the

investor to reach his highest feasible level of utility.

42. B

0.15(8%) + 0.2(7%) + 0.15(6%) + 0.3(9%) + 0.2(11%) = 8.4%.

43. B

0.2(16% - 13%)2] 1/2 = 2.449%; sB = [0.15(8% - 8.4%)2 + 0.2(7% - 8.4%)2 + 0.15(6% 8.4%)2 + 0.3(9% - 8.4%)2 + 0.2(11% - 8.4%)2 ] 1/2 = 1.676%.

44. C

covA,B = 0.15(8% - 13%)(8% - 8.4%) + 0.2(13% - 13%)(7% - 8.4%) + 0.15(12% 13%)(6% - 8.4%) + 0.3(14% - 13%)(9% - 8.4%) + 0.2(16% - 13%)(11% - 8.4%) = 2.40;

rA,B = 2.40/[(2.45)(1.68)] = 0.583.

45. C

2(0.35)(0.65)(2.45)(1.68)(0.583)]1/2 = 1.7%.

46. Answer: B

47. Answer: D

48. Answer: D

49. Answer: A

50. Answer: C

51. Answer: D

52. Answer: D

53. Answer: A

54. Answer: B

55. Answer: B

56. Answer: B

57. Answer: A

58.B

Before: 1.12 = 0.95(bR) + 0.05(1.0); 0.95(bR) = 1.07; bR = 1.13.

After: bP = 0.95(bR) + 0.05(2.0) = 1.07 + 0.10 = 1.17.

59. B

60. C

61. A

62. A

The hurdle rate should be the required return from CAPM or (R = 4% + 1.4(11% - 4%) =

11%.

63. Answer: A

64. Answer: C

65. Answer: B

66. Answer: C

67. Answer: D

68. Answer: D

69. Answer: D

70. Answer: A

71. Answer: C

72. Answer: B

73. Answer: C

74. D

Technicians attempt to predict future stock prices based on historical stock prices.

75. E

Individual investors tend to have relatively small portfolios and are usually unable to

realize economies of size. The best strategy is to pool funds with other small investors

and allow professional managers to invest the funds.

76. B

AR = 14% - (5% + 1.0 (6%)) = +3.0%. A positive abnormal return suggests that there

was firm-specific good news.

The exam will have 20 multiple choice questions and 4 work problems.

Questions in the multiple choice section will be either concept or calculation

questions. The calculation questions will be similar to those in the quizzes,

assignment, and review. However, the concept questions will be related to any

topic we have covered in the class. The concept questions in the review are only

some sample questions. You should NOT study only topics in the review.

For the work problems, you need to solve the problems without knowing the

possible answers. The questions will be similar to those in the quizzes,

assignment, and review except that the possible solutions are not given.

You can bring a formula sheet to the exam.

The final exam schedules are as follows:

o Final Exams for Classes Meeting Tu-Th at 9:30am Thursday, May 15

o

8:00 AM - 11:00 AM

Final Exams for Classes Meeting Tu-Th at 11am Monday, May 19

11:30 AM - 2:30 PM

Chapter 12

RISK PREMIUM

1. The excess return required from a risky asset over that required from a risk-free asset is

called the:

a. risk premium.

b. geometric premium.

c. excess return.

d. average return.

e. variance.

STRONG FORM EFFICIENCY

2. The hypothesis that market prices reflect all available information of every kind is

called _____ form efficiency.

a. open

b. strong

c. semi-strong

d. weak

e. stable

DIVIDEND YIELD

3. The dividend yield is equal to _____, where P1 is the purchase cost, P2 represents the

sale proceeds, and d is the dividend income.

a. d P1

b. d P1

c. d P2

d. d P2

e. d (P1 + P2)

HISTORICAL RECORD

4. Based on the period of 1926 through 2003, _____ have tended to outperform other

securities over the long-term.

a. U.S. Treasury bills

b. large company stocks

c. long-term corporate bonds

d. small company stocks

e. long-term government bonds

RISK PREMIUM

5. Which one of the following is a correct statement concerning risk premium?

a. The greater the volatility of returns, the greater the risk premium.

b. The lower the volatility of returns, the greater the risk premium.

c. The lower the average rate of return, the greater the risk premium.

d. The risk premium is not correlated to the average rate of return.

e. The risk premium is not affected by the volatility of returns.

MARKET EFFICIENCY

6. In an efficient market, the price of a security will:

a. always rise immediately upon the release of new information with no further price

adjustments related to that information.

b. react to new information over a two-day period after which time no further price

adjustments related to that information will occur.

c. rise sharply when new information is first released and then decline to a new stable

level by the following day.

d.

react immediately to new information with no further price adjustments related to that

information.

e. be slow to react for the first few hours after new information is released allowing time

for that information to be reviewed and analyzed.

MARKET EFFICIENCY

7. Your best friend works in the finance office of the Delta Corporation. You are aware

that this friend trades Delta stock based on information he overhears in the office. You

know that this information is not known to the general public. Your friend continually

brags to you about the profits he earns trading Delta stock. Based on this information,

you would tend to argue that the financial markets are at best _____ form efficient.

a. weak

b. semiweak

c. semistrong

d. strong

e. perfect

DOLLAR RETURNS

8. One year ago, you purchased a stock at a price of $32.50. The stock pays quarterly

dividends of $.40 per share. Today, the stock is worth $34.60 per share. What is the

total amount of your dividend income to date from this investment?

a. $.40

b. $1.60

c. $2.10

d. $2.50

e. $3.70

Chapter 13

PRINCIPLE OF DIVERSIFICATION

9. The principle of diversification tells us that:

a. concentrating an investment in two or three large stocks will eliminate all of your risk.

b. concentrating an investment in three companies all within the same industry will

greatly reduce your overall risk.

c. spreading an investment across five diverse companies will not lower your overall risk

at all.

d. spreading an investment across many diverse assets will eliminate all of the risk.

e. spreading an investment across many diverse assets will eliminate some of the risk.

EXPECTED RETURN

10. You are considering purchasing stock S. This stock has an expected return of 8 percent

if the economy booms and 3 percent if the economy goes into a recessionary period.

The overall expected rate of return on this stock will:

a. be equal to one-half of 8 percent if there is a 50 percent chance of an economic boom.

b. vary inversely with the growth of the economy.

c. increase as the probability of a recession increases.

d. be equal to 75 percent of 8 percent if there is a 75 percent chance of a boom economy.

e. increase as the probability of a boom economy increases.

DIVERSIFIABLE RISKS

11. Which one of the following is an example of diversifiable risk?

b. the employees of Textile, Inc. just voted to go on strike

c. the government just imposed new safety standards for all employees

d. the government just lowered corporate income tax rates

e. the cost of group health insurance just increased nationwide

NONDIVERSIFIABLE RISKS

12. Which one of the following is an example of a nondiversifiable risk?

a. a well respected president of a firm suddenly resigns

b. a well respected chairman of the Federal Reserve suddenly resigns

c. a key employee of a firm suddenly resigns and accepts employment with a key

competitor

d. a well managed firm reduces its work force and automates several jobs

e. a poorly managed firm suddenly goes out of business due to lack of sales

13. Which one of the following events is considered part of the expected return on Fido

stock?

a. The president of Fido suddenly announced that the firm is going to cut production

effective immediately.

b. The government just announced a tax cut which will directly impact the sales of Fido.

c. The management of Fido announced their ten-year plan for expansion five years ago.

d. The price of Fido stock suddenly dropped due to rumors concerning company fraud.

e. Fido just won a major government contract which they had not anticipated winning.

TOTAL RISK

14. _____ measures total risk.

a. The mean

b. Beta

c. The geometric average

d. The standard deviation

e. The arithmetic average

SYSTEMATIC RISK

15. Systematic risk is measured by:

a. the mean.

b. beta.

c. the geometric average.

d. the standard deviation.

e. the arithmetic average.

SYSTEMATIC RISK

16. Which of the following risks are relevant to a well-diversified investor?

I.

systematic risk

II. unsystematic risk

III. market risk

IV. nondiversifiable risk

a. I and III only

b. II and IV only

c. II, III, and IV only

d. I, II, and IV only

UNSYSTEMATIC RISK

17. Which one of the following is an example of unsystematic risk?

a. the inflation rate increases unexpectedly

b. the federal government lowers income taxes

c. an oil tanker runs aground and spills its cargo

d. interest rates decline by one-half of one percent

e. the GDP rises by 2 percent more than anticipated

SYSTEMATIC RISK PRINCIPLE

18. The systematic risk principle implies that the _____ an asset depends only on that

assets systematic risk.

a. variance of the returns on

b. standard deviation of the returns on

c. expected return on

d. total risk assumed by owning

e. diversification benefits of

SECURITY MARKET LINE (SML)

19. A stock with an actual return that lies above the security market line:

a. has more systematic risk than the overall market.

b. has more risk than warranted based on the realized rate of return.

c. has yielded a higher return than expected for the level of risk assumed.

d. has less systematic risk than the overall market.

e. has yielded a return equivalent to the level of risk assumed.

CAPITAL ASSET PRICING MODEL (CAPM)

20. A security that has a rate of return that exceeds the U.S. Treasury bill rate but is less

than the market rate of return must:

a. be a risk-free asset.

b. have a beta that is greater than 1.0 but less than 2.0.

c. be a risk-free asset with a beta less than .99.

d. be a risky asset with a standard deviation less than 1.0.

e. be a risky asset with a beta less than 1.0.

EXPECTED RETURN

21. You are comparing stock A to stock B. Given the following information, which one of

these two stocks should you prefer and why?

Rate of Return if

State of

Probability of

State Occurs

Economy

State of Economy

Stock A Stock B

Boom

60%

9%

15%

Recession

40%

4%

-6%

a. Stock A; because it has an expected return of 7 percent and appears to be more risky.

b. Stock A; because it has a higher expected return and appears to be less risky than stock

B.

c. Stock A; because it has a slightly lower expected return but appears to be significantly

less risky than stock B.

d. Stock B; because it has a higher expected return and appears to be just slightly more

risky than stock A.

e. Stock B; because it has a higher expected return and appears to be less risky than stock

A.

22. A portfolio is expected to return 7 percent in a normal economy, 14 percent in a boom economy, and

lose 20 percent in a recessionary economy. The probability of a recession is 20 percent while

the probability of a boom is 5 percent. What is the standard deviation of the portfolio?

a. 7.89 percent

b. 9.32 percent c. 10.87 percent d. 11.08 percent

23. What is the expected return on a portfolio comprised of $4,000 in stock M and $6,000

in stock N if the economy enjoys a boom period?

State of

Economy

Boom

Normal

Recession

a.

b.

c.

d.

e.

Probability of

State of Economy

10%

75%

15%

Stock M

Stock N

18%

10%

7%

8%

-20%

6%

6.4 percent

6.8 percent

10.4 percent

13.2 percent

14.0 percent

BETA

24. What is the beta of a portfolio comprised of the following securities?

Stock

A

B

C

a.

b.

c.

d.

e.

Amount

Invested

$2,000

$3,000

$5,000

Security

Beta

1.20

1.46

.72

1.008

1.014

1.038

1.067

1.127

25. The stock of Martin Industries has a beta of 1.43. The risk-free rate of return is 3.6

percent and the market risk premium is 9 percent. What is the expected rate of return

on Martin Industries stock?

a. 11.3 percent

b. 14.1 percent

c. 16.5 percent

d. 17.4 percent

e. 18.0 percent

Chapter 15

COST OF EQUITY

26. The return that shareholders require on their investment in the firm is called the:

a. dividend yield.

b. cost of equity.

c. capital gains yield.

d. cost of capital.

e. income return.

PURE PLAY APPROACH

27. When firms develop a WACC for individual projects based on the cost of capital for

other firms in similar lines of business as the project, the firm is utilizing a _____

approach.

a. subjective risk

b. pure play

c. divisional cost of capital

d. capital adjustment

e. security market line

COST OF EQUITY

28. A firms overall cost of equity is:

I.

directly observable in the financial markets.

II. unaffected by changes in the market risk premium.

III. highly dependent upon the growth rate and risk level of a firm.

IV. an estimate only.

a. I and III only

b. II and IV only

c. I and II only

d. III and IV only

e. I and IV only

DIVIDEND GROWTH MODEL

29. The dividend growth model:

a. can be used to estimate the cost of equity for any corporation.

b. is applicable only to firms that pay a constant dividend.

c. is highly dependent upon the estimated rate of growth.

d. is considered quite complex.

e. considers the risk of the firm.

COST OF DEBT

30. The pre-tax cost of debt for a firm:

a. is equal to the yield to maturity on the outstanding bonds of the firm.

b. is equal to the coupon rate of the outstanding bonds of the firm.

c. is equivalent to the current yield on the outstanding bonds of the firm.

d. is based on the yield to maturity that existed when the currently outstanding bonds were

originally issued.

e. has to be estimated as it cannot be directly observed in the market.

CAPITAL STRUCTURE WEIGHTS

31. The capital structure weights used in computing the weighted average cost of capital

are:

a. constant over time provided that the debt-equity ratio changes in unison with the

market values.

b. based on the face value of the firms debt.

c. computed using the book value of the long-term debt and the shareholders equity.

d. based on the market value of the firms debt and equity securities.

e. limited to the firms debt and common stock.

WEIGHTED AVERAGE COST OF CAPITAL

32. Which one of the following statements is correct concerning the weighted average cost

of capital (WACC)?

a. The pre-tax rate of return on the debt is the rate that is relevant to the computation of

the WACC.

b. When computing the WACC, the weight assigned to the preferred stock is equal to the

coupon rate multiplied by the par value assigned to the preferred stock.

c. A firms WACC will decrease as their corporate tax rate decreases.

d. The weight of the common stock used in the computation of the WACC is based on the

number of shares outstanding multiplied by the book value per share.

e. The weight of the debt can be based on the face value of the bond issue(s) outstanding

multiplied by the quoted price(s) when expressed as a percentage of the face value.

COST OF EQUITY

33. Martin Industries just paid an annual dividend of $1.20 a share. The market price of

the stock is $26.60 and the growth rate is 4 percent. What is the firms cost of equity?

a. 8.38 percent

b. 8.51 percent

c. 8.57 percent

d. 8.69 percent

e. 8.74 percent

COST OF EQUITY

34. Daniels Enterprises has a beta of 1.98 and a growth rate of 12 percent. The stock is

currently selling for $12 a share. The overall stock market has an 11 percent rate of

return and a risk premium of 8 percent. What is the expected rate of return on Daniels

Enterprises stock?

a. 10.00 percent

b. 15.85 percent

c. 16.67 percent

d. 18.84 percent

e. 19.06 percent

COST OF DEBT

35. The Bet-r-Bilt Company has a six-year bond outstanding with a 5 percent coupon.

Interest payments are paid semi-annually. The face amount of the bond is $1,000. This

bond is currently selling for 98 percent of its face value. What is the companys pre-tax

cost of debt?

a. 4.72 percent

b. 5.31 percent

c. 5.35 percent

d. 5.39 percent

e. 5.42 percent

AFTER-TAX COST OF DEBT

36. Toms Ventures has a zero coupon bond issue outstanding that matures in thirteen

years. The bonds are selling at 48 percent of par value. The companys tax rate is 34

percent. What is the companys after-tax cost of debt?

a.

b.

c.

d.

e.

3.83 percent

4.11 percent

4.73 percent

4.80 percent

5.81 percent

37. Peters Audio Shop has a cost of debt of 7 percent, a cost of equity of 11 percent, and a

cost of preferred stock of 8 percent. The firm has 104,000 shares of common stock

outstanding at a market price of $20 a share. There are 40,000 shares of preferred stock

outstanding at a market price of $34 a share. The bond issue has a total face value of

$500,000 and sells at 102 percent of face value. The companys tax rate is 34 percent.

What is the weighted average cost of capital for Peters Audio Shop?

a. 6.14 percent

b. 6.54 percent

c. 8.60 percent

d. 9.14 percent

e. 9.45 percent

38. Watsons Automotive has a $400,000 bond issue outstanding that is selling at 102

percent of face value. Watsons also has 4,500 shares of preferred stock and 21,000

shares of common stock outstanding. The preferred stock has a market price of $44 a

share compared to a price of $21 a share for the common stock. What is the weight of

the debt as it relates to the firms weighted average cost of capital?

a. 38 percent

b. 39 percent

c. 40 percent

d. 41 percent

e. 42 percent

1.

2.

3.

4.

5.

6.

7.

8.

b

a

d

a

d

c

b

Dividend income = $.40 4 = $1.60

9. e

10. e

11. b

12. b

13. c

14 . d

15. b

16. e

17. c

18. c

19. c

20. e

21. b

E(r)A = (.60 .09) + (.40 .04) = .054 + .016 = .07 = 7 percent

E(r)B = (.60 .15) + (.40 -.06) = .09 .024 = .066 = 6.6 percent

You should select stock A because it has a higher expected return and also appears to be

less risky.

B

22. d

E(R) = [(.75 .07) + (.05 .14) + (.20 -.20)] = (.0525 + .007 .040) = .0195

Std dev = .75 (.07 .0195)2 + .05 (.14 .0195)2 + .20 (-.20 .0195)2 = .00191269 +

.00072601 + .00963605 = .01227475 = 11.08 percent

23. d

E(r)Boom = [($4,000 ($4,000 + $6,000) .18] + [$6,000 ($4,000 + $6,000) .10] =

.072 + .06 = .132 = 13.2 percent

24. c

.

BetaPortfolio = ($2,000 $10,000 1.20) + ($3,000 $10,000 1.46) + ($5,000 $10,000

.72) = .24 + .438 + .36 = 1.038

25. c

.

26. b

27. b

28. d

29. c

30. a

31. d

32. e

33. d

Re =

$1.20 1.04

+ .04 = 8.69 percent

$26.60

34. d

Re = (.11 .08) + (1.98 .08) = 18.84 percent

35. d

Enter

62

N

Solve for

2/

I/Y

5.39

980

PV

50/2 1000

PMT FV

36. a

480

1000

I/Y

PV

PMT FV

Solve for

5.81

After-tax Rd = 5.81 percent (1 .34) = 3.83 percent

Enter

13

N

37. d

Debt:

$500,000 1.02 = $ .51m

Preferred:

40,000 $34 = $1.36m

Common:

104,000 $20 = $2.08m

Total = $.51m + $1.36m + $2.08m = $3.95m

$2.08m

$1.36m

$.51m

WACC =

.11 +

.08 +

.07 (1 .34) = .057924 + .027544

$3.95m

$3.95m

$3.95m

38. b

Debt:

$400,000 1.02 = $408,000

Preferred:

4,500 $44 = $198,000

Common:

21,000 $21 = $441,000

Total = $408,000 + $198,000 + $441,000 = $1,047,000

WeightDebt = $408,000 $1,047,000 = 39 percent

relationship from lowest to highest between securities is:

Treasury bills, government bonds, corporate bonds, large

common stocks, small company stocks.

The Zolo Co. just declared that it is increasing its annual

dividend from $1.00 per share to $1.25 per share. If the stock

price remains constant, then:

the dividend yield will increase.

Which of the following statements are correct concerning the

variance of the annual returns on an investment?

I. The larger the variance, the more the actual returns tend to

differ from the average return.

II. The larger the variance, the larger the standard deviation.

III. The larger the variance, the greater the risk of the investment.

IV. The larger the variance, the higher the expected return.

Estimates using the arithmetic average will probably tend to

_____ values over the long-term while estimates using the

geometric average will probably tend to _____ values over the

short-term.

overestimate; underestimate

Which one of the following is an example of systematic risk?

the Federal Reserve increases interest rates

The Capital Market Line is the pricing relationship between:

beta and the standard deviation of portfolio return.

The intercept point of the security market line is the rate of

return which corresponds to:

the risk-free rate of return.

Which one of the following measures is relevant to the

systematic risk principle?

beta

Diversification will not lower the ____ risk:

systematic risk.

Which one of the following statements is correct concerning the

expected rate of return on an individual stock given various

states of the economy?

of the economic states are used as the weights.

You are considering purchasing stock S. This stock has an

expected return of 8% if the economy booms and 3% if the

economy goes into a recessionary period. The overall expected

rate of return on this stock will:

increase as the probability of a boom economy increases.

Question 1

2 / 2 pts

The capital gains yield plus the dividend yield on a security is called the:

total return.

geometric return.

variance of returns.

current yield.

Question 2

2 / 2 pts

A symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation is the

_____ distribution.

normal

Poisson

bi-modal

uniform

gamma

IncorrectQuestion 3

0 / 2 pts

Capital market history shows us that the average return relationship from lowest to highest between securities is:

inflation, corporate bonds, Treasuries, small company stocks, large company stocks.

Treasury bills, corporate bonds, government bonds, large common stocks, small company stocks.

There is no ordering.

Treasury bills, government bonds, corporate bonds, large common stocks, small company stocks.

Question 4

2 / 2 pts

A portfolio of large company stocks would contain which one of the following types of securities?

stocks of the firms which represent the smallest 20% of the companies listed on the NYSE

Question 5

2 / 2 pts

The average compound return earned per year over a multi-year period is called the _____ average return.

geometric

variant

real

arithmetic

standard

Question 6

2 / 2 pts

A capital gain occurs when:

Question 7

2 / 2 pts

The return earned in an average year over a multi-year period is called the _____ average return.

real

geometric

standard

variant

arithmetic

Question 8

2 / 2 pts

Which one of the following is a correct statement concerning risk premium?

The greater the volatility of returns, the greater the risk premium.

The lower the volatility of returns, the greater the risk premium.

The lower the average rate of return, the greater the risk premium.

Question 9

2 / 2 pts

How much of total world stock market capitalization is from the United States in 2011?

Approximately 25%

Approximately 10%

Approximately 45%

Approximately 57%

Approximately 72%

Question 10

2 / 2 pts

Skip to question text.

Which of the following statements concerning the standard deviation are correct?

I. The greater the standard deviation, the lower the risk.

II. The standard deviation is a measure of volatility.

III. The higher the standard deviation, the less certain the rate of return in any one given year.

IV. The higher the standard deviation, the higher the expected return.

Question 11

2 / 2 pts

Total risk can be divided into:

Question 12

2 / 2 pts

Which one of the following is an example of systematic risk?

Question 13

2 / 2 pts

The primary purpose of portfolio diversification is to:

IncorrectQuestion 14

0 / 2 pts

Diversification can effectively reduce risk. Once a portfolio is diversified the type of risk remaining is:

None of these.

IncorrectQuestion 15

2 / 2 pts

The elements in the off-diagonal positions of the variance/covariance matrix are:

security selections.

security weights.

variances.

None of these.

covariances.

Question 16

2 / 2 pts

You are considering purchasing stock S. This stock has an expected return of 8% if the economy booms and 3% if

the economy goes into a recessionary period. The overall expected rate of return on this stock will:

IncorrectQuestion 17

2 / 2 pts

A well-diversified portfolio has eliminated most of the:

expected return.

systematic risk.

unsystematic risk.

variance.

Question 18

2 / 2 pts

Systematic risk is measured by:

the mean.

beta.

Question 19

2 / 2 pts

Risk that affects at most a small number of assets is called _____ risk.

total

nondiversifiable

market

portfolio

unsystematic

IncorrectQuestion 20

0 / 2 pts

The diversification effect of a portfolio of two stocks:

None of these.

Both increases as the correlation between the stocks declines; and decreases as the correlation between the stocks

rises.

IncorrectQuestion 21

0 / 2 pts

You have a portfolio of two risky stocks which turns out to have no diversification benefit. The reason you have no

diversification is the returns:

Question 22

2 / 2 pts

If the covariance of stock 1 with stock 2 is - .0065, then what is the covariance of stock 2 with stock 1?

-.0065

+.0065

IncorrectQuestion 23

2 / 2 pts

Which one of the following is an example of unsystematic risk?

IncorrectQuestion 24

2 / 2 pts

The total number of variance and covariance terms in a portfolio is N2. How many of these would be (including

non-unique) covariances?

N2- N/2

N2- N

N2

None of these.

IncorrectQuestion 25

2 / 2 pts

If the correlation between two stocks is -1, the returns:

None of these.

IncorrectQuestion 26

2 / 2 pts

Beta measures:

All of these.

IncorrectQuestion 27

2 / 2 pts

A security that is fairly priced will have a return _____ the Security Market Line.

on or below

on

above

below

on or above

Question 28

2 / 2 pts

Which one of the following statements is correct concerning the expected rate of return on an individual stock given

various states of the economy?

The expected return is a geometric average where the probabilities of the economic states are used as the

exponential powers.

The expected return is a weighted average where the probabilities of the economic states are used as the weights.

The expected return is an arithmetic average of the individual returns for each state of the economy.

The expected return is equal to the summation of the values computed by dividing the expected return for each

economic state by the probability of the state.

As long as the total probabilities of the economic states equal 100%, then the expected return on the stock is a

geometric average of the expected returns for each economic state.

IncorrectQuestion 29

2 / 2 pts

Skip to question text.

You have plotted the data for two securities over time on the same graph, i.e., the monthly return of each security for

the last 5 years. If the pattern of the movements of each of the two securities rose and fell as the other did, these two

securities would have:

no correlation at all.

IncorrectQuestion 30

2 / 2 pts

The opportunity set of portfolios is:

71. The elements along the diagonal of the variance/covariance matrix are:

A.covariances.

B.security weights.

C.security selections.

D.variances.

E.None of the above.

Difficulty level: MediumTopic: VARIANCE-COVARIANCE MATRIXType: CONCEPTS

72. The elements in the off-diagonal positions of the variance/covariance matrix are:

A.covariances.

B.security selections.

C.variances.

D.security weights.

E.None of the above.

68. The total number of variance and covariance terms in a portfolio is N2. How many ofthese would be (including

non-unique) covariances?

A.N

B.N2

C.N2- N

D.N2- N/2

E.None of the above.

Difficulty level: MediumTopic: COVARIANCEType: CONCEPTS

A.expected return.

B.unsystematic risk.

C.systematic risk.

D.variance.

E.Both C and D

1. The excess return required on a risky investment over that of a risk-free investment is called the:

a. inflation premium.

b. required return.

c. real return.

d. average actual return.

E. risk premium.

2. The variance is the:

a. difference between the actual return and the average return.

b. difference between the actual return and the average return divided by N

1.

C. average squared difference between the actual return and the average return.

d. average squared difference between the actual return and the average return divided by N

e. square root of the standard deviation.

1.

3. The average compound return earned per year over a multiyear period is called the _____ return.

a. standardized mean

B. geometric average

c. annual percentage

d. arithmetic average

e. real

4. The hypothesis that stock markets, such as the NYSE, are efficient is called the:

a. market equalization hypothesis.

b. Fisher effect.

C. efficient markets hypothesis.

d. capital market hypothesis.

e. financial markets hypothesis.

5. This morning, you sold a dividend-paying stock that you purchased last year. Your total percentage return is

equal to:

a. (P0

P1 + D1) / P0.

B. (P1

P0 + D1) / P0.

c. D1 / P0.

d. (P1

P0) / P1.

e. P1 / P0.

6. The return on which one of the following is used as the risk-free rate of return?

a. long-term corporate bonds

b. long-term government bonds

c. short-term corporate bonds

D. U.S. Treasury bills

e. the Consumer Price Index

a. average value

b. frequency

C. volatility

d. mean

e. arithmetic average

8. Wellington Goods pays a constant dividend. Last year, the dividend yield was 4.6 percent when the stock was

selling for $42 a share. What must the stock price be if the market currently requires a 4.0 percent dividend yield

on this stock?

a. $41.70

b. $42.10

c. $47.50

D. $48.30

e. $48.80

9. One year ago, you bought a stock for $21.40 a share. You received a dividend of $1.90 per share last month and

sold the stock today for $19.80 a share. What is the capital gains yield on this investment?

a. 8.08 percent

B. 7.48 percent

c. 5.47 percent

d. 1.40 percent

e. 1.52 percent

10. Liz earned a 3.1 percent real rate of return on her investments for the past year. During that time, the risk-free

rate was 3.7 percent and the inflation rate was 2.9 percent. What was her nominal rate of return?

a. 5.78 percent

b. 6.00 percent

C. 6.09 percent

d. 6.80 percent

e. 6.91 percent

11. Last year, Neal invested $5,000 in Tattler's stock, $5,000 in long-term government bonds, and $5,000 in U.S.

Treasury bills. Over the course of the year, he earned returns of 9.7 percent, 5.4 percent, and 3.8 percent,

respectively. What was the risk premium on Tattler's stock for the year?

a. 4.08 percent

b. 4.30 percent

c. 5.21 percent

d. 5.68 percent

E. 5.90 percent

12. Five years ago, you purchased 200 shares of RST stock. The annual returns have been 9.8 percent, 6.4 percent,

7.5 percent, 1.2 percent, and 10.6 percent, respectively for those five years. What is the variance of these returns?

a. .0008

B. .0014

c. .0027

d. .0049

e. .0063

13. Your portfolio has provided you with returns of 7.9 percent, 11.2 percent, 3.8 percent, and 14.7 percent over

the past four years, respectively. What is the geometric average return for this period?

a. 8.98 percent

b. 9.16 percent

C. 9.33 percent

d. 9.40 percent

e. 9.44 percent

14. Systematic risk is:

A. a risk that affects a large number of assets.

b. the total risk inherent in an individual security.

c. also called diversifiable risk.

d. also called asset-specific risk.

e. unique to an individual firm.

15. The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is

called the:

a. risk premium.

B. beta coefficient.

c. standard deviation.

d. mean.

e. variance.

16. The slope of the security market line is referred to as the:

a. market alpha.

B. market risk premium.

c. diversification benefit.

d. systematic risk premium.

e. expected return.

17. The equation that is represented graphically by the security market line is called the:

a. capital market function.

b. portfolio diversification model.

c. bell curve.

D. capital asset pricing model.

e. market risk model.

18. Systematic risk:

a. is diversifiable.

b. is the total risk associated with surprise events.

c. affects a small number of securities.

D. is measured by beta.

e. is measured by standard deviation.

19. The goal of diversification is to eliminate:

a. all investment risk.

b. the market risk premium.

c. systematic risk.

D. unsystematic risk.

e. the effects of beta.

20. A U.S. Treasury bill has a beta of _____ while the overall market has a beta of _____.

a. 0; 0

B. 0; 1

c. 1; 0

d. 1; 1

e. infinity; 1

21. If a security plots below the security market line, then the security:

a. is under-priced.

B. is overpriced.

c. is correctly priced.

d. has a beta greater than 1.0.

e. has a beta less than 1.0.

22. The stock of Chocolate Galore is expected to produce the following returns given the various states of the

economy. What is the expected return on this stock?

a. 7.33 percent

b. 9.82 percent

C. 11.26 percent

d. 11.33 percent

e. 11.50 percent

23. The cost of equity for ABC Industries is defined as the:

a. firm's weighted average cost of capital multiplied by the firm's beta.

b. yield to maturity on the firm's debt multiplied by one minus the tax rate.

c. market rate of return multiplied by the firm's beta.

D. return that ABC's shareholders require on their investment in the firm.

e. next year's dividend divided by the current stock price.

24. The weighted average cost of capital is defined as the weighted average of a firm's:

a. return on its investments.

B. cost of equity and its aftertax cost of debt.

c. pretax cost of debt and equity securities.

d. bond coupon rates.

e. dividend and capital gains yields.

a. decreases when the firm's tax rate decreases.

b. is another terms for the firm's return on equity.

c. varies inversely with the firm's pre-tax cost of debt.

D. is the required return on the existing assets of the firm.

e. is the required return for each of a firm's proposed projects.

26. The cost of preferred stock:

a. decreases when a firm's tax rate increases.

b. is constant over time.

c. is unaffected by changes in the price of the stock.

D. is equal to the stock's dividend yield.

e. increases as the price of the stock increases.

27. A firm has a cost of equity of 10 percent, a cost of preferred of 9 percent, and an aftertax cost of debt of 5

percent. Given this, which one of the following will decrease the firm's weighted average cost of capital?

a. redeeming the bond issue

b. decreasing the debt-equity ratio

c. issuing new equity securities

d. increasing the systematic risk level of the firm

E. issuing new debt

28. The cost of capital for a project is primarily determined by the project's:

a. life span.

b. initial cost.

C. level of risk.

d. source of funds.

e. internal rate of return.

29. Deltronics just paid its first annual dividend of $.20 a share. The firm plans to increase the dividend by 4

percent per year indefinitely. What is the firm's cost of equity if the current stock price is $11 a share?

a. 5.82 percent

B. 5.89 percent

c. 6.33 percent

d. 6.48 percent

e. 6.54 percent

30. Ziegler's Supply has a beta of 1.06, a variance of .0124, a dividend growth rate of 2.8 percent, a stock price of

$27 a share, and an expected annual dividend of $1.10 per share next year. The market rate of return is 10.8

percent and the risk-free rate is 4.1 percent. What is the cost of equity for Ziegler's Supply?

a. 6.89 percent

b. 7.87 percent

c. 8.48 percent

D. 9.04 percent CAPM = 11.2%, so throw out.

e. 11.19 percent

31. Juno has 8 percent bonds outstanding that mature in 19 years. The bonds pay interest semiannually and have a

face value of $1,000. Currently, the bonds are selling for $989 each. What is Juno's pre-tax cost of debt?

a. 8.09 percent

B. 8.11 percent

c. 8.14 percent

d. 8.18 percent

e. 8.23 percent

32. Cobblestone Tours has 10,000 bonds that are currently quoted at 103.6. The bonds mature in 9 years and carry

a 10 percent annual coupon. What is Cobblestone Tour's aftertax cost of debt if the applicable tax rate is 34

percent?

A. 6.20 percent (Incorrect should be 6.60. Question will be thrown out.)

b. 6.27 percent

c. 7.17 percent

d. 9.28 percent

e. 9.39 percent

33. A

Ross Chapter 12

--A portfolio is

a group of assets, such as stocks and bonds, held as a collective

unit by an investor.

The average squared difference between the actual return and

the average return is called the

variance

The standard deviation for a set of stock returns can be

calculated as the

average squared difference between the actual return and the

average return.

A symmetric, bell-shaped frequency distribution that is

completely defined by its mean and standard deviation is the

_____ distribution.

normal

The average compound return earned per year over a multi-year

period is called the _____ average return.

geometric

The return earned in an average year over a multi-year period is

called the _____ average return.

arithmetic

An efficient capital market is one in which

security prices reflect available information.

The notion that actual capital markets, such as the NYSE, are

fairly priced is called the:

Efficient Markets Hypothesis (EMH)

The hypothesis that market prices reflect all available

information of every kind is called _____ form efficiency

strong

The hypothesis that market prices reflect all publicly-available

information is called _____ form efficiency

semi-strong

information is called _____ form efficiency

weak

The Zolo Co. just declared that they are increasing their annual

dividend from $1.00 per share to $1.25 per share. If the stock

price remains constant, then:

the dividend yield will increase

The capital gains yield plus the dividend yield on a security is

called the:

total return

The real rate of return on a stock is approximately equal to the

nominal rate of return:

minus the inflation rate

As long as the inflation rate is positive, the real rate of return on

a security investment will be ____ the nominal rate of return.

less than

The average risk premium on U.S. Treasury bills over the period

of 1926 to 2003 was _____ percent

0.0

Which one of the following is a correct statement concerning

risk premium?

The greater the volatility of returns, the greater the risk premium.

The risk premium is computed by ______ the average return

for the investment

subtracting the average return on the U.S. Treasury bill from

The excess return you earn by moving from a relatively risk-free

investment to a risky investment is called the

risk premium

To convince investors to accept greater volatility in the annual

rate of return on an investment, you must:

increase the risk premium

Which one of the following takes the shape of a bell curve?

frequency distribution

Which of the following statements are correct concerning the

variance of the annual returns on an investment

I. The larger the variance, the more the actual returns tend to

differ from the average return.

II. The larger the variance, the larger the standard deviation.

III. The larger the variance, the greater the risk of the investment.

IV. The larger the variance, the higher the expected return.

The variance of returns is computed by dividing the sum of the:

squared deviations by the number of returns minus one.

Estimates using the arithmetic average will probably tend to

_____ values over the long-term while estimates using the

geometric average will probably tend to _____ values over the

short-term.

overestimate

underestimate

In an efficient market, the price of a security will:

react immediately to new information with no further price

adjustments related to that information.

If the financial markets are efficient, then investors should

expect their investments in those markets to:

generally have zero net present values.

Which one of the following statements is correct concerning

market efficiency?

A firm will generally receive a fair price when it sells shares of

stock.

Financial markets fluctuate daily because they:

are continuously reacting to new information

Insider trading does not offer any advantages if the financial

markets are:

strong-form efficient

Individuals that continually monitor the financial markets

seeking mispriced securities:

tend to make the markets more efficient

mutual fund

an investment company that invests its shareholders' money in a

diversified portfolio of securities

drawbacks of mutual funds

transaction costs:

-management fee

-commission fee on load funds

lower than market performance:

-Consistently beating the market is difficult

-Many mutual funds just keep even with overall stock market

index

mutual funds - management co

runs funds daily ops

mutual funds - investment advisor

buys and sells stocks or bonds and oversees the investment

portfolio

mutual funds - distributor

sells the fund shares

-direct to the public

-through brokers

mutual funds - custodian

physically safeguards the securities

mutual funds - transfer agent

keeps track of purchases and redemption requests from

shareholders

open-end investment co's

investors buy and sell shares directly with the mutual fnd

company without a secondary market

have unlimited # of shares

NAV = value of all securities - liabilities total shares outstanding

closed-end investment co's

sell only after the initial offering

-subseq trades are done in a secondary mkt, similar to the

limited number of shares

investment advisor doesn't have to worry about cash inflows or

outflows

det my supply and demand

sell at premium or discount to NAV

exchange traded funds

basket of secs designed to track a specific market index

Chapter 09

The Capital Asset Pricing Model

Multiple Choice Questions

1. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is

A. unique risk.

B. beta.

C. standard deviation of returns.

D. variance of returns.

E. none of the above.

Once, a portfolio is diversified, the only risk remaining is systematic risk, which is measured by

beta.

Difficulty: Easy

3. In the context of the Capital Asset Pricing Model (CAPM) the relevant risk is

A. unique risk.

B. market risk

C. standard deviation of returns.

D. variance of returns.

E. none of the above.

Once, a portfolio is diversified, the only risk remaining is systematic risk, which is measured by

beta.

Difficulty: Easy

4. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of

return is a function of

A. market risk

B. unsystematic risk

C. unique risk.

D. reinvestment risk.

E. none of the above.

With a diversified portfolio, the only risk remaining is market, or systematic, risk. This is the

only risk that influences return according to the CAPM.

Difficulty: Easy

5. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of

return is a function of

A. beta risk

B. unsystematic risk

C. unique risk.

D. reinvestment risk.

E. none of the above.

With a diversified portfolio, the only risk remaining is market, beta, or systematic, risk. This is

the only risk that influences return according to the CAPM.

Difficulty: Easy

8. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively.

According to the capital asset pricing model (CAPM), the expected rate of return on security X

with a beta of 1.2 is equal to

A. 0.06.

B. 0.144.

C. 0.12.

D. 0.132

E. 0.18

E(R) = 6% + 1.2(12 - 6) = 13.2%.

Difficulty: Easy

A. It includes all publicly traded financial assets.

B. It lies on the efficient frontier.

C. All securities in the market portfolio are held in proportion to their market values.

D. It is the tangency point between the capital market line and the indifference curve.

E. All of the above are true.

The tangency point between the capital market line and the indifference curve is the optimal

portfolio for a particular investor.

Difficulty: Moderate

12. Which statement is not true regarding the Capital Market Line (CML)?

A. The CML is the line from the risk-free rate through the market portfolio.

B. The CML is the best attainable capital allocation line.

C. The CML is also called the security market line.

D. The CML always has a positive slope.

E. The risk measure for the CML is standard deviation.

Both the Capital Market Line and the Security Market Line depict risk/return relationships.

However, the risk measure for the CML is standard deviation and the risk measure for the SML

is beta (thus C is not true; the other statements are true).

Difficulty: Moderate

A. the covariance between the security's return and the market return divided by the variance of

the market's returns.

B. the covariance between the security and market returns divided by the standard deviation of

the market's returns.

C. the variance of the security's returns divided by the covariance between the security and

market returns.

D. the variance of the security's returns divided by the variance of the market's returns.

E. none of the above.

Beta is a measure of how a security's return covaries with the market returns, normalized by the

market variance.

Difficulty: Moderate

A. the line that describes the expected return-beta relationship for well-diversified portfolios

only.

B. also called the Capital Allocation Line.

C. the line that is tangent to the efficient frontier of all risky assets.

D. the line that represents the expected return-beta relationship.

E. the line that represents the relationship between an individual security's return and the

market's return.

The SML is a measure of expected return per unit of risk, where risk is defined as beta

(systematic risk).

Difficulty: Moderate

17. According to the Capital Asset Pricing Model (CAPM), fairly priced securities

A. have positive betas.

B. have zero alphas.

C. have negative betas.

D. have positive alphas.

E. none of the above.

A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).

Difficulty: Moderate

18. According to the Capital Asset Pricing Model (CAPM), underpriced securities

A. have positive betas.

B. have zero alphas.

C. have negative betas.

D. have positive alphas.

E. none of the above.

According to the Capital Asset Pricing Model (CAPM), under priced securities have positive

alphas.

Difficulty: Moderate

19. According to the Capital Asset Pricing Model (CAPM), overpriced securities

A. have positive betas.

B. have zero alphas.

C. have negative betas.

D. have positive alphas.

E. none of the above.

According to the Capital Asset Pricing Model (CAPM), over priced securities have negative

alphas.

Difficulty: Moderate

21. According to the Capital Asset Pricing Model (CAPM), which one of the following

statements is false?

A. The expected rate of return on a security decreases in direct proportion to a decrease in the

risk-free rate.

B. The expected rate of return on a security increases as its beta increases.

C. A fairly priced security has an alpha of zero.

D. In equilibrium, all securities lie on the security market line.

E. All of the above statements are true.

Statements B, C, and D are true, but statement A is false.

Difficulty: Moderate

23. Empirical results regarding betas estimated from historical data indicate that

A. betas are constant over time.

B. betas of all securities are always greater than one.

C. betas are always near zero.

D. betas appear to regress toward one over time.

E. betas are always positive.

Betas vary over time, betas may be negative or less than one, betas are not always near zero;

however, betas do appear to regress toward one over time.

Difficulty: Moderate

24. Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of

1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to the

Capital Asset Pricing Model, this security is

A. underpriced.

B. overpriced.

C. fairly priced.

D. cannot be determined from data provided.

E. none of the above.

11% = 5% + 1.5(9% - 5%) = 11.0%; therefore, the security is fairly priced.

Difficulty: Moderate

25. The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If you expect

a stock with a beta of 1.3 to offer a rate of return of 12 percent, you should

A. buy the stock because it is overpriced.

B. sell short the stock because it is overpriced.

C. sell the stock short because it is underpriced.

D. buy the stock because it is underpriced.

E. none of the above, as the stock is fairly priced.

12% < 7% + 1.3(15% - 7%) = 17.40%; therefore, stock is overpriced and should be shorted.

( = 12 17.40 = -5.40% - overpriced, or undervalued)

Difficulty: Moderate

27. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate

of return is 0.08 and the risk-free rate is 0.05. The alpha of the stock is

A. 1.7%.

B. -1.7%.

C. 8.3%.

D. 5.5%.

E. none of the above.

= 10% - [5% +1.1(8% - 5%)] = 1.7%.

Difficulty: Moderate

28. Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3. The

risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital

Asset Pricing Model, this security is

A. underpriced.

B. overpriced.

C. fairly priced.

D. cannot be determined from data provided.

E. none of the above.

11.5% - [4% + 1.3(11.5% - 4%)] = -2.25%; therefore, the security is overpriced.

Difficulty: Moderate

31. Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92. The

risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital

Asset Pricing Model, this security is

A. underpriced.

B. overpriced.

C. fairly priced.

D. cannot be determined from data provided.

E. none of the above.

11.2% - [4% + 0.92(10% - 4%)] = 1.68%; therefore, the security is under priced.

Difficulty: Moderate

34. As a financial analyst, you are tasked with evaluating a capital budgeting project. You were

instructed to use the IRR method and you need to determine an appropriate hurdle rate. The riskfree rate is 4 percent and the expected market rate of return is 11 percent. Your company has a

beta of 1.0 and the project that you are evaluating is considered to have risk equal to the average

project that the company has accepted in the past. According to CAPM, the appropriate hurdle

rate would be ______%.

A. 4

B. 7

C. 15

D. 11

E. 1

The hurdle rate should be the required return from CAPM or (R = 4% + 1.0(11% - 4%) = 11%.

Difficulty: Moderate

36. As a financial analyst, you are tasked with evaluating a capital budgeting project. You were

instructed to use the IRR method and you need to determine an appropriate hurdle rate. The riskfree rate is 4 percent and the expected market rate of return is 11 percent. Your company has a

beta of 0.75 and the project that you are evaluating is considered to have risk equal to the

average project that the company has accepted in the past. According to CAPM, the appropriate

hurdle rate would be ______%.

A. 4

B. 9.25

C. 15

D. 11

E. 0.75

The hurdle rate should be the required return from CAPM or (R = 4% + 0.75(11% - 4%) =

9.25%.

Difficulty: Moderate

39. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect

CAT with a beta of 1.0 to offer a rate of return of 10 percent, you should

A. buy stock X because it is overpriced.

B. sell short stock X because it is overpriced.

C. sell stock short X because it is underpriced.

D. buy stock X because it is underpriced.

E. none of the above, as the stock is fairly priced.

10% < 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is overpriced and should be shorted.

( = 10 11 = -1% - overpriced, or undervalued)

Difficulty: Moderate

If the expected market rate of return is 0.09 and the risk-free rate is 0.05, which security would

be considered the better buy and why?

A. A because it offers an expected excess return of 1.2%.

B. B because it offers an expected excess return of 1.8%.

C. A because it offers an expected excess return of 2.2%.

D. B because it offers an expected return of 14%.

E. B because it has a higher beta.

A's excess return is expected to be 12% - [5% + 1.2(9% - 5%)] = 2.2%. B's excess return is

expected to be 14% - [5% + 1.8(9% - 5%)] = 1.8%.

Difficulty: Moderate

45. According to the CAPM, the risk premium an investor expects to receive on any stock or

portfolio increases:

A. directly with alpha.

B. inversely with alpha.

C. directly with beta.

D. inversely with beta.

E. in proportion to its standard deviation.

The market rewards systematic risk, which is measured by beta, and thus, the risk premium on a

stock or portfolio varies directly with beta.

Difficulty: Easy

47. Standard deviation and beta both measure risk, but they are different in that

A. beta measures both systematic and unsystematic risk.

B. beta measures only systematic risk while standard deviation is a measure of total risk.

C. beta measures only unsystematic risk while standard deviation is a measure of total risk.

D. beta measures both systematic and unsystematic risk while standard deviation measures only

systematic risk.

E. beta measures total risk while standard deviation measures only nonsystematic risk.

B is the only true statement.

Difficulty: Easy

A. is the most familiar expression of the CAPM to practitioners.

B. refers to the way in which the covariance between the returns on a stock and returns on the

market measures the contribution of the stock to the variance of the market portfolio, which is

beta.

C. assumes that investors hold well-diversified portfolios.

D. all of the above are true.

E. none of the above are true.

Statements A, B and C all describe the expected return-beta relationship.

Difficulty: Moderate

50. Research by Jeremy Stein of MIT resolves the dispute over whether beta is a sufficient

pricing factor by suggesting that managers should use beta to estimate

A. long-term returns but not short-term returns.

B. short-term returns but not long-term returns.

C. both long- and short-term returns.

D. book-to-market ratios.

E. None of the above was suggested by Stein.

Stein's results suggest that managers should use beta to estimate long-term returns but not shortterm returns.

Difficulty: Difficult

A. liquid stocks earn higher returns than illiquid stocks.

B. illiquid stocks earn higher returns than liquid stocks.

C. both liquid and illiquid stocks earn the same returns.

D. illiquid stocks are good investments for frequent, short-term traders.

E. None of the above are true.

Studies of liquidity spreads in security markets have shown that illiquid stocks earn higher

returns than liquid stocks.

Difficulty: Difficult

A. the average degree of risk aversion of the investor population.

B. the risk of the market portfolio as measured by its variance.

C. the risk of the market portfolio as measured by its beta.

D. both A and B are true.

E. both A and C are true.

The risk premium on the market portfolio is proportional to the average degree of risk aversion

of the investor population and the risk of the market portfolio measured by its variance.

Difficulty: Moderate

55. In equilibrium, the marginal price of risk for a risky security must be

A. equal to the marginal price of risk for the market portfolio.

B. greater than the marginal price of risk for the market portfolio.

C. less than the marginal price of risk for the market portfolio.

D. adjusted by its degree of nonsystematic risk.

E. none of the above are true.

In equilibrium, the marginal price of risk for a risky security must be equal to the marginal price

of risk for the market. If not, investors will buy or sell the security until they are equal.

Difficulty: Moderate

A. all investors are price takers.

B. all investors have the same holding period.

C. investors pay taxes on capital gains.

D. both A and B are true.

E. A, B and C are all true.

The CAPM assumes that investors are price-takers with the same single holding period and that

there are no taxes or transaction costs.

Difficulty: Easy

A. all investors are price takers.

B. all investors have the same holding period.

C. investors have homogeneous expectations.

D. both A and B are true.

E. A, B and C are all true.

The CAPM assumes that investors are price-takers with the same single holding period and that

they have homogeneous expectations.

Difficulty: Easy

A. the CAPM is no longer valid.

B. the CAPM underlying assumptions are not violated.

C. the implications of the CAPM are not violated as long as investors' liquidity needs are not

priced.

D. the implications of the CAPM are no longer useful.

E. none of the above are true.

This is discussed in the chapter's section about extensions to the CAPM. It examines what the

consequences are when the assumptions are removed.

Difficulty: Moderate

62. The amount that an investor allocates to the market portfolio is negatively related to

I) the expected return on the market portfolio.

II) the investor's risk aversion coefficient.

III) the risk-free rate of return.

IV) the variance of the market portfolio

A. I and II

B. II and III

C. II and IV

D. II, III, and IV

E. I, III, and IV

The optimal proportion is given by y = (E(RM) - rf)/(.01xA2M). This amount will decrease as rf,

A, and 2M increase.

Difficulty: Moderate

63. One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does

this mean?

A. They plan for one identical holding period.

B. They are price-takers who can't affect market prices through their trades.

C. They are mean-variance optimizers.

D. They have the same economic view of the world.

E. They pay no taxes or transactions costs.

Myopic behavior is shortsighted, with no concern for medium-term or long-term implications.

Difficulty: Moderate

65. Which of the following statements about the mutual fund theorem is true?

I) It is similar to the separation property.

II) It implies that a passive investment strategy can be efficient.

III) It implies that efficient portfolios can be formed only through active strategies.

IV) It means that professional managers have superior security selection strategies.

A. I and IV

B. I, II, and IV

C. I and II

D. III and IV

E. II and IV

The mutual fund theorem is similar to the separation property. The technical task of creating

mutual funds can be delegated to professional managers; then individuals combine the mutual

funds with risk-free assets according to their preferences. The passive strategy of investing in a

market index fund is efficient.

Difficulty: Moderate

68. For the CAPM that examines illiquidity premiums, if there is correlation among assets due to

common systematic risk factors, the illiquidity premium on asset i is a function of

A. the market's volatility.

B. asset is volatility.

C. the trading costs of security i.

D. the risk-free rate.

E. the money supply.

The formula for this extension to the CAPM relaxes the assumption that trading is costless.

Difficulty: Moderate

78. Assume that a security is fairly priced and has an expected rate of return of 0.13. The market

expected rate of return is 0.13 and the risk-free rate is 0.04. The beta of the stock is ___?

A. 1.25

B. 1.7

C. 1

D. 0.95

E. none of the above.

13% = [4% +(13% - 4%)]; 9% = (9%); = 1.

Difficulty: Moderate

NAME: _______________________________

BSAD 180: Managerial Finance

Final Exam

I. Multiple Choices (40%)

(

d

a.

b.

c.

d.

e.

b

a.

b.

c.

d.

e.

c

a.

b.

c.

d.

e.

) 1.

A stock had returns of 8%, -2%, 4%, and 16% over the past four years. What is the

standard deviation of this stock for the past four years?

6.3%

6.6%

7.1%

7.5%

7.9%

) 2.

The percentage of a portfolios total value invested in a particular asset is called that

assets:

portfolio return.

portfolio weight.

portfolio risk.

rate of return.

investment value.

)3.

Risk that affects a large number of assets, each to a greater or lesser degree, is called

_____ risk.

idiosyncratic

diversifiable

systematic

asset-specific

total

a )4.

The amount of systematic risk present in a particular risky asset, relative to the systematic

risk present in an average risky asset, is called the particular assets:

a. beta coefficient.

b. reward-to-risk ratio.

c. total risk.

d. diversifiable risk.

e. Treynor index.

b )5.

Which one of the following is an example of a nondiversifiable risk?

a. a well respected president of a firm suddenly resigns

b. a well respected chairman of the Federal Reserve suddenly resigns

c. a key employee suddenly resigns and accepts employment with a key competitor

d. a well managed firm reduces its work force and automates several jobs

e. a poorly managed firm suddenly goes out of business due to lack of sales

c

a.

b.

c.

d.

e.

)6.

Diversification can effectively reduce risk. Once a portfolio is diversified, the type of risk

remaining is:

individual security risk.

riskless security risk.

systematic risk.

total standard deviations.

None of the above.

)7.

Jacks Construction Co. has 80,000 bonds outstanding that are selling at par value.

Bonds with similar characteristics are yielding 8.5%. The company also has

4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for

$40 a share. The U.S. Treasury bill is yielding 4% and the market risk premium

is 8%. Jacks tax rate is 35%. What is Jacks weighted average cost of capital?

a. 7.10 %

b. 7.39 %

c. 10.38 %

d. 10.65 %

e. 11.37 %

a.

b.

c.

d.

e.

)8.

Assuming the CAPM or one-factor model holds, what is the cost of equity for a firm if

the firm's equity has a beta of 1.2, the risk-free rate of return is 2%, the expected return on the

market is 9%, and the return to the company's debt is 7%?

10.4%

10.8%

12.8%

14.4%

None of the above.

c )9.

Which of the following will increase sustainable growth?

a. Buy back existing stock

b. Decrease debt

c. Increase profit margin

d. Increase asset requirement ratio

e. Increase dividend payout ratio

b )10.

Wilberts, Inc. paid $90,000, in cash, for a piece of equipment three years ago. Last year,

the company spent $10,000 to update the equipment with the latest technology. The company

no longer uses this equipment in its current operations and has received an offer of $50,000

from a firm who would like to purchase it. Wilberts is debating whether to sell the equipment

or to expand its operations such that the equipment can be used. When evaluating the

expansion option, what value, if any, should Wilberts assign to this equipment as an initial

cost of the project?

a. $40,000

b. $50,000

c. $60,000

d. $80,000

e. $90,000

1. (a) Please draw the efficient frontier for a portfolio of N>2 risky assets (with x-axis and y-axis properly

labeled). (b) When the risk-free asset is included into the portfolio, what happened to the optimal feasible

set?

2. Is it possible that a risky asset could have a beta of zero? Explain. Based on the CAPM, what is the

expected return on such an asset? Is it possible that a risky asset could have a negative beta? What does

the CAPM predict about the expected return on such an asset?

3. Johnson Inc. is considering a new project that has a life of 3 years. The initial capital (fixed assets)

investment for the project is $75,000. The firms use 3-year straight-line depreciation (with no salvage

value) to write off the capital investment. The firm needs to invest $20,000 in net working capital (NWC)

for the project and expects to recover this investment at the end of the project. In addition to the initial

capital investment, the project requires the use of a vacant site owned by the firm. The present value of

the opportunity cost for this site is estimated to be $12,000. The firm uses no debt. The beta of the firm is

0.8. The T-bill rate is 3%. The expected market risk premium is 8%. What is the NPV of the project?

The pro forma income statements for year 1, year 2, and year 3 are the same. For each year, it looks like

the following:

Sales (50,000 units at $6.00/unit)

Variable Costs ($4/unit)

Gross profit

Fixed costs

Depreciation

EBIT

Taxes (20%)

Net Income

$300,000

$200,000

$100,000

$40,000

$25,000

$35,000

$7,000

$ 28,000

4. Security F has an expected return of 12% and a standard deviation of 34% per year. Security G has an

expected return of 18% and a standard deviation of 50% per year. (a) What is the expected return on a

portfolio composed of 40% of security F and 60% of security G? (b) If the correlation coefficient

between F and G is 0.1, what is the standard deviation of the portfolio described in part (a)?

5. (a) Please define the term separation. (b) Please discuss the Du Pont identity. (c) Please define the

term sunk costs. Should sunk costs be included into the calculation of NPV?

6. The most recent financial statements for Martin, Inc., are as follows.

Sales

Costs

Taxable Income

Taxes (34%)

NI

$19,200

$15,550

$3,650

$1,241

$2,409

Assets $93,000

Debt $20,400

Equity $72,600

Total $93,000

Assets and costs are proportional to sales. Debt and Equity are not. A dividend of $1,156 is expected to

be paid in the coming year. Sales are projected to be $23,040 in the coming year. What external

financing is needed for the coming year?

EXTRA QUESTIONS!

1.

An investment returns 10% in the first year and -10% in the second year. What is the

(arithmetic) average return of the investment?

a. 0

b. 1%

c. -1%

d. 0.5%

e. -0.5%

f. You must be kidding.

a.

b.

c.

d.

e.

f.

0

1%

-1%

0.5%

-0.5%

You must be kidding.

3. Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk.

a. idiosyncratic

b. diversifiable

c. systematic

d. asset-specific

e. total

4.

Risk that affects at most a small number of assets is called _____ risk.

a. portfolio

b. undiversifiable

c. market

d. unsystematic

e. total

a. concentrating an investment in two or three large stocks will eliminate all of your risk.

b. concentrating an investment in three companies all within the same industry will greatly

reduce your overall risk.

c. spreading an investment across five diverse companies will not lower your overall risk at

all.

d. spreading an investment across many diverse assets will eliminate all of the risk.

e. spreading an investment across many diverse assets will eliminate some of the risk.

6. The amount of systematic risk present in a particular risky asset, relative to the systematic risk

present in an average risky asset, is called the particular assets:

a. beta coefficient.

b. reward-to-risk ratio.

c. total risk.

d. diversifiable risk.

e. Treynor index.

7. You are considering purchasing stock S. This stock has an expected return of 8 percent if the

economy booms and 3 percent if the economy goes into a recessionary period. The overall

expected rate of return on this stock will:

a. be equal to one-half of 8 percent if there is a 50 percent chance of an economic boom.

b. vary inversely with the growth of the economy.

c. increase as the probability of a recession increases.

d. be equal to 75 percent of 8 percent if there is a 75 percent chance of a boom economy.

e. increase as the probability of a boom economy increases.

8. Which of the following are examples of nondiversifiable risks?

I.

the inflation rate spikes nationwide

II.

an unexpected terrorist event occurs

III.

the price of lumber suddenly spikes

IV.

taxes are increased on hotels

a. I and III only

b. II and IV only

c. I and II only

d. II and III only

e. I, II, and IV only

9. Which of the following statements concerning nondiversifiable risk are correct?

I.

Nondiversifiable risk is measured by standard deviation.

II.

Systematic risk is another name for nondiversifiable risk.

III.

The risk premium increases as the nondiversifiable risk increases.

IV.

Nondiversifiable risks are those risks you can not avoid if you are invested

in the financial markets.

a. I and III only

b. II and IV only

c. I, II, and III only

d. II, III, and IV only

e. I, II, III, and IV

10. Which one of the following is an example of a nondiversifiable risk?

a. a well respected president of a firm suddenly resigns

b. a well respected chairman of the Federal Reserve suddenly resigns

c. a key employee of a firm suddenly resigns and accepts employment with a key

competitor

d. a well managed firm reduces its work force and automates several jobs

e. a poorly managed firm suddenly goes out of business due to lack of sales

11. The risk premium for an individual security is computed by:

a. multiplying the securitys beta by the market risk premium.

b. multiplying the securitys beta by the risk-free rate of return.

c. adding the risk-free rate to the securitys expected return.

d. dividing the market risk premium by the quantity (1 beta).

e. dividing the market risk premium by the beta of the security.

a. total

b. nondiversifiable

c. unsystematic

d. systematic

e. economic

13. The systematic risk of the market is measured by:

a. a beta of 1.0.

b. a beta of 0.0.

c. a standard deviation of 1.0.

d. a standard deviation of 0.0.

e. a variance of 1.0.

14. Which one of the following portfolios should have the most systematic risk?

a. 50 percent invested in U.S. Treasury bills and 50 percent in a market index mutual fund

b. 20 percent invested in U.S. Treasury bills and 80 percent invested in a stock with a beta

of .80

c. 10 percent invested in a stock with a beta of 1.0 and 90 percent invested in a stock with a

beta of 1.40

d. 100 percent invested in a mutual fund which mimics the overall market

e. 100 percent invested in U.S. Treasury bills

15. A security that is fairly priced will have a return that lies _____ the Security Market Line.

a. below

b. on or below

c. on

d. on or above

e. above

16. BLANK

17. The market risk premium is computed by:

a. adding the risk-free rate of return to the inflation rate.

b. adding the risk-free rate of return to the market rate of return.

c. subtracting the risk-free rate of return from the inflation rate.

d. subtracting the risk-free rate of return from the market rate of return.

e. multiplying the risk-free rate of return by a beta of 1.0.

18. You recently purchased a stock that is expected to earn 12 percent in a booming economy, 8

percent in a normal economy and lose 5 percent in a recessionary economy. There is a 15 percent

probability of a boom, a 75 percent chance of a normal economy, and a 10 percent chance of a

recession. What is your expected rate of return on this stock?

a. 5.00 percent

b. 6.45 percent

c. 7.30 percent

d. 7.65 percent

e. 8.30 percent

19. You want your portfolio beta to be 1.20. Currently, your portfolio consists of $100

invested in stock A with a beta of 1.4 and $300 in stock B with a beta of .6. You have

another $400 to invest and want to divide it between an asset with a beta of 1.6 and a

risk-free asset. How much should you invest in the risk-free asset?

a. $0

b. $140

c. $200

d. $320

e. $400

20. You have a $1,000 portfolio which is invested in stocks A and B plus a risk-free asset.

$400 is invested in stock A. Stock A has a beta of 1.3 and stock B has a beta of .7. How much

needs to be invested in stock B if you want a portfolio beta of .90?

a. $0

b. $268

c. $482

d. $543

e. $600

21. You are comparing stock A to stock B. Given the following information, which one of these two

stocks should you prefer and why?

Rate of Return if

State of

Probability of

State Occurs

Economy

State of Economy

Stock A Stock B

Boom

60%

9%

15%

Recession

40%

4%

-6%

a. Stock A; because it has an expected return of 7 percent and appears to be more risky.

b. Stock A; because it has a higher expected return and appears to be less risky than stock B.

c. Stock A; because it has a slightly lower expected return but appears to be significantly

less risky than stock B.

d. Stock B; because it has a higher expected return and appears to be just slightly more risky

than stock A.

e. Stock B; because it has a higher expected return and appears to be less risky than stock A.

22. Zelo, Inc. stock has a beta of 1.23. The risk-free rate of return is 4.5 percent and the market rate

of return is 10 percent. What is the amount of the risk premium on Zelo stock?

a. 4.47 percent

b. 5.50 percent

c. 5.54 percent

d. 6.77 percent

e. 12.30 percent

23. Suppose you know that the returns for stock XYZ for the past 5 years have been 6%, 1.5%, -8%,

-2% and 5.5%. What is the total risk, expressed as standard deviation, of this stock? (Use: /(n1))

a.

b.

c.

d.

e.

1.4%

2.7%

3.5%

4.2%

5.8%

24. You own the following portfolio of stocks. What is the portfolio weight of stock C?

Number

Stock of Shares

A

100

B

600

C

400

D

200

a.

b.

c.

d.

e.

Price

per Share

$22

$17

$46

$38

30.8 percent

37.4 percent

42.3 percent

45.2 percent

47.9 percent

25. What is the expected return on a portfolio comprised of $3,000 in stock K and $5,000 in stock L

if the economy is normal?

a.

b.

c.

d.

e.

State of

Economy

Boom

Normal

3.75 percent

5.25 percent

5.63 percent

5.88 percent

6.80 percent

Probability of

State of Economy

20%

80%

Stock K

Stock L

14%

10%

5%

6%

Amount

Security

Stock

A

B

C

a.

b.

c.

d.

e.

Invested

$2,000

$3,000

$5,000

Beta

1.20

1.46

.72

1.008

1.014

1.038

1.067

1.127

CHALLENGE: You would like to combine a risky stock with a beta of 1.5 with U.S. Treasury bills

in such a way that the risk level of the portfolio is equivalent to the risk level of the overall market.

What percentage of the portfolio should be invested in Treasury bills?

a. .25

b. .33

c. .50

d. .67

e. .75

26A The market has an expected rate of return of 9.8 percent. The long-term government

bond is expected to yield 4.5 percent and the U.S. Treasury bill is expected to yield 3.4

percent. The inflation rate is 3.1 percent. What is the market risk premium?

a. 2.2 percent

b. 3.3 percent

c. 5.3 percent

d. 6.4 percent

e. 6.7 percent

27 A The risk-free rate of return is 4 percent and the market risk premium is 8 percent. What

is the expected rate of return on a stock with a beta of 1.28?

a.

9.12 percent

b.

10.24 percent

c.

13.12 percent

d.

14.24 percent

e.

15.36 percent

27. The return that shareholders require on their investment in the firm is called the:

a. dividend yield.

b. cost of equity.

c. capital gains yield.

d. cost of capital.

e. income return.

28. The return that lenders require on their loaned funds to the firm is called the:

a. coupon rate.

b. current yield.

c. cost of debt.

d. capital gains yield.

e. cost of capital.

29. The proportions of the market value of the firms assets financed via debt, common

stock, and preferred stock are called the firms:

a.

b.

c.

d.

e.

financing costs.

portfolio weights.

beta coefficients.

capital structure weights.

costs of capital.

30. The weighted average of the firms costs of equity, preferred stock, and aftertax debt is

the:

a. reward to risk ratio for the firm.

b. expected capital gains yield for the stock.

c. expected capital gains yield for the firm.

d. portfolio beta for the firm.

e. weighted average cost of capital (WACC).

31. The costs incurred by the firm when new issues of stocks or bonds are sold are called:

a. required rates of return.

b. costs of capital.

c. flotation costs.

d. capital structure weights.

e. costs of equity and debt.

f.

a. determined by directly observing the rate of return required by equity investors.

b. based on estimates derived from financial models.

c. equivalent to a leveraged firms cost of capital.

d. equal to the risk-free rate of return plus the market risk premium.

e. equal to the risk-free rate of return plus the dividend growth rate.

33. The pre-tax cost of debt for a firm:

a. is equal to the yield to maturity on the outstanding bonds of the firm.

b. is equal to the coupon rate of the outstanding bonds of the firm.

c. is equivalent to the current yield on the outstanding bonds of the firm.

d. is based on the yield to maturity that existed when the currently outstanding bonds were

originally issued.

e. has to be estimated as it cannot be directly observed in the market.

34. The capital structure weights used in computing the weighted average cost of capital

are:

a. constant over time provided that the debt-equity ratio changes in unison with the

market values.

b. based on the face value of the firms debt.

c. computed using the book value of the long-term debt and the shareholders equity.

d. based on the market value of the firms debt and equity securities.

e. limited to the firms debt and common stock.

35. Bens Ice Cream just paid their annual dividend of $.75 a share. The stock has a market price of

$32 and a beta of .90. The return on the U.S. Treasury bill is 4 percent and the market has a 12

percent rate of return. What is the cost of equity?

a.

b.

c.

d.

e.

7.24 percent

8.67 percent

11.20 percent

12.92 percent

14.80 percent

36. The Bet-r-Bilt Company has a six-year bond outstanding with a 5 percent coupon. Interest

payments are paid semi-annually. The face amount of the bond is $1,000. This bond is currently

selling for 98 percent of its face value. What is the companys pre-tax cost of debt?

a. 4.72 percent

b. 5.31 percent

c. 5.35 percent

d. 5.39 percent

e. 5.42 percent

37. Katies Boutique has zero-coupon bonds outstanding that mature in four years. The

bonds have a face value of $1,000 and a current market price of $820. What is the

companys pre-tax cost of debt?

a.

b.

c.

d.

e.

5.01 percent

5.09 percent

5.18 percent

5.36 percent

5.49 percent

38. Ernsts Electrical has a bond issue outstanding with ten years to maturity. These bonds

have a $1,000 face value, a 5 percent coupon, and pay interest semi-annually. The

bonds are currently quoted at 96 percent of face value. What is Ernsts pre-tax cost of

debt?

a. 4.47 percent

b. 4.97 percent

c. 5.33 percent

d. 5.53 percent

e. 5.94 percent

39. Blackwater Adventures has a bond issue outstanding that matures in sixteen years. The

bonds pay interest semi-annually. Currently, the bonds are quoted at 103 percent of

face value and carry a 9 percent coupon. The firms tax rate is 34 percent. What is the

firms after-tax cost of debt?

a. 5.19 percent

b. 5.71 percent

c. 7.86 percent

d. 8.65 percent

e. 11.41 percent

40. Jensens Travel Agency has a 7 percent preferred stock outstanding that is currently selling for

$48 a share. The market rate of return is 10 percent and the firms tax rate is 34 percent. What is

the Jensens cost of preferred stock?

a. 8.75 percent

b. 9.62 percent

c. 11.98 percent

d. 13.25 percent

e. 14.58 percent

41. The Auto Group has 1,200 bonds outstanding that are selling for $980 each. The ompany also

has 7,500 shares of preferred stock at a market price of $40 each. The common stock is priced at

$32 a share and there are 32,000 shares outstanding. What is the weight of the preferred stock as

it relates to the firms weighted average cost of capital?

a. 10 percent

b. 12 percent

c. 14 percent

d. 16 percent

e. 18 percent

42. Jacks Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with

similar characteristics are yielding 8.5 percent. The company also has 4 million shares of

common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S.

Treasury bill is yielding 4 percent and the market risk premium is 8 percent. Jacks tax rate is 35

percent. What is Jacks weighted average cost of capital?

a. 7.10 percent

b. 7.39 percent

c. 10.38 percent

d. 10.65 percent

e. 11.37 percent

43. Peters Audio Shop has a cost of debt of 7 percent, a cost of equity of 11 percent, and a cost of

preferred stock of 8 percent. The firm has 104,000 shares of common stock outstanding at a

market price of $20 a share. There are 40,000 shares of preferred stock outstanding at a market

price of $34 a share. The bond issue has a total face value of $500,000 and sells at 102 percent of

face value. The companys tax rate is 34 percent. What is the weighted average cost of capital for

Peters Audio Shop?

a. 6.14 percent

b. 6.54 percent

c. 8.60 percent

d. 9.14 percent

e. 9.45 percent

Economics 4000

Final Examination Practice Questions

1. The present value of a set of cash flows is:

A) the weighted average of present values of individual cash flows

B) the sum of individual cash flows which are then discounted.

C) the sum of the present values of the individual cash flows

D) always greater than the present value of the investment.

E) the weighted average of individual cash flows, which is then discounted

Answer: C

2. Which of the following statements is true?

A) Regardless of the value of the interest rate, increasing the compounding

frequency will decrease the future value.

B) Regardless of the value of the interest rate, increasing the compounding

frequency will increase the future value.

C) There is a relationship between the future value of investment and the effect

of compounding frequency. At high interest rates, increases in compounding

frequency will decrease the future value.

D) There is a relationship between the future value of investment and the effect

of compounding frequency. At low interest rates, increases in compounding

frequency will decrease the future value.

Answer: B

3.The P/E (price to earnings) ratio of a stock is __________ related to growth potential,

__________ related to the discount rate, and __________ related to the stock's

risk.

A) positively, positively, negatively.

D) negatively, negatively,

positively.

B) negatively, positively, positively.

E) none of the above.

C) positively, negatively, negatively.

Answer: C

4. Zeta Corporation has issued a $1,000 face value zero-coupon bond. Which of the

following values is closest to the correct price for the bond if the appropriate

discount rate is 4% and the bond matures in 8 years?

A) $ 960.

B) $ 730.

C) $ 1,000.

D) $ 1,350

E) $32,000.

Answer: B

5.The market price of_____ maturity bonds fluctuates _____ compared

with_____maturity bonds as interest rates change.

A) shorter, less, longer

C) shorter, more, longer

1

E) past, more, future

Answer: A

D) both b and c

6. Which of the following values is closest to the amount that should be paid for a stock

that will pay a dividend of $10 one year from now and $11 two years from now?

The stock will be sold in 2 years for an estimated price of $120. The appropriate

discount rate is 9%.

A) $114. B) $119. C) $124. D) $129. E) $138.

Answer: B

7. Mortgage Instruments Inc. is expected to pay dividends of $1.03 next year. The

company just paid dividends of $1. This growth rate is expected to continue.

How much should be paid for Mortgage Instruments stock just after the dividend

if the appropriate discount rate is 5%.

A) $20. B) $21. C) $34. D) $50. E) $52.

Answer: E

8. The yield to maturity is:

A) the rate that equates the price of the bond with the discounted cashflows.

B) the expected rate to be earned if held to maturity.

C) the rate that is used to determine the market price of the bond.

D) equal to the current yield for bonds priced at par.

E) all of the above.

Answer: E

9.A project will have only one internal rate of return if:

A) all cash flows after the initial expense are positive.

B) average accounting return is positive.

C) net present value is negative.

D) net present value is positive.

E) net present value is zero.

Answer: A

10. Which of the following does not characterize NPV as an investment rule?

A) NPV is the simplest of all investment rules.

B) NPV incorporates all relevant information.

C) NPV uses all of the project's cash flows.

D) NPV discounts all future cash flows.

Answer: A

11. To be able to estimate the expected return on the market portfolio, you would need to

know or estimate:

A) the beta of the portfolio, the risk-free rate, and the level of the market over the

next year.

B) the risk-free rate and beta of the portfolio.

C) the historical risk premium and the risk free rate.

D) the level of the market over the next year, the risk-free rate, and the historical

risk premium.

E) none of the above is sufficient.

Answer: C

12. If the expected return on the market is 14%, then using the approximate historical risk

premium, the current risk-free rate is:

A) 4.5%. B) 8%. C) 12.5%. D) 14.5%. E) 18.5%.

Answer: B

13.You bought 100 shares of stock at $10 each. At the end of the year, you received a

total of $200 in dividends, and your stock was worth $1,250 total. What was your

total return?

A) 45%. B) 50%. C) 90%. D) 20%. E) None of the above.

Answer: A

14. The efficient set of portfolios:

A) contains the portfolio combinations with the highest return for a given level of

risk

B) contains the portfolio combinations with the lowest risk for a given level of

return

C) is the lowest overall risk portfolio

D) a and b

E) a and c.

Answer: D

15. Imagine you have a portfolio of two risky stocks which turns out to have no

diversification. The reason you have no diversification is:

A) the returns are too small

B) the returns move perfectly opposite of one another

C) the returns are too large to offset

D) the returns move perfectly with one another

E) the returns are completely unrelated to one another

Answer: D

16. Stock A has an expected return of 20%, and stock B has an expected return of 4%.

However, the risk of stock A as measured by its variance is 3 times that of stock

B. If the two stocks are combined equally in a portfolio, what would be the

portfolio's expected return?

A) 20.0%.

D) Greater than 20%.

B) 4.0%.

E) Need more information.

C) 12.0%.

Answer: C

17. If the covariance of stock 1 with stock 2 is -.0065, then what is the covariance of

stock 2 with stock 1?

A) -.0065.

B) +.0065.

C) greater than +.0065.

Answer: A

E) Need additional information.

18. A portfolio has 50% of its funds invested in Security One and 50% of its funds

invested in Security Two. Security One has a standard deviation of 6. Security

Two has a standard deviation of 12. The securities have a coefficient of

correlation of .5. Which of the following values is closest to portfolio variance?

A) 81.

B) 90.

C) 27.

D) 9.

E) One must have covariance to calculate expected value.

Answer: A The question did not ask for the exact value (which is 63)

19. Shareholders discount many corporate announcements because of their prior

expectations. If an announcement causes the price to change it will mostly be

driven by:

A) the expected part of the announcement.

B) market inefficiency.

C) the innovation or unexpected part of the announcement.

D) the systematic risk.

E) None of the above.

Answer: C

20. A stock with a beta of zero would be expected to:

A) have a rate of return equal to the risk-free rate.

B) have a rate of return equal to the market rate.

C) have a rate of return equal to zero.

D) have a rate of return equal to the one.

Answer: A

21. Companies that have highly cyclical sales will have:

A) a low beta if sales are highly dependent on the market cycle.

B) a high beta if sales are highly dependent on the market cycle.

C) a high beta if sales are independent on the market cycle.

D) all of the above.

E) none of the above.

Answer: B

22. If a firm has low fixed costs relative to all other firms in the same industry, a large

change in volume (either up or down) would have:

A) a smaller change in EBIT for the firm versus the other firms.

B) no effect in any way on the firms as volume does not effect fixed costs.

C) a decreasing effect on the cyclical nature of the business.

D) a large change in EBIT for the firm versus the other firms.

4

Answer: A

23. The beta of a firm depends on which of the following firm characteristics?

A) Cycles in revenues.

D) All of the above.

B) Operating leverage (fixed cost/variable cost) E) None of the above.

C) Financial leverage (debt/equity)

Answer: D

24. Regression analysis can be used to

A) estimate beta.

B) estimate the risk-free rate.

C) estimate standard deviations.

Answer: A

D) estimate variances.

E) estimate expected returns.

25. Which of the following does not represent a major difference between debt and

equity?

A) Creditors do not have voting power as stockholders do.

B) Payment on interest on debt in considered an expense, while payment of

dividends is not.

C) Unpaid debt is a liability of the firm, and if not paid, can result in liquidation

of the firm. Unpaid dividends cannot.

D) One of the costs of issuing equity is the possibility of financial distress, while

no financial distress is associated with debt.

E) None of the above.

Answer: D

26. The market value of the ownership of the firm equals:

A) the market price of the stock times the number of shares outstanding.

B) the sum of the market price of the bonds and the stock.

C) the par value of the stock times the number of shares outstanding.

D) the market price of the stock minus the retained earnings.

E) none of the above.

Answer: A

27. Retained earnings are:

A) the amount of cash that the firm has saved up.

B) the difference between the net income earned and the dividends paid in a year.

C) the difference between the market price of the stock and the book value.

D) the amount of stock repurchased.

E) none of the above.

Answer: B

28. Financial leverage impacts the performance of the firm by:

A) increasing the volatility of the firm's EBIT.

B) decreasing the volatility of the firm's EBIT.

C) decreasing the volatility of the firm's net income.

5

E) none of the above.

Answer: D

29. When comparing levered vs. unlevered capital structures, leverage works to increase

EPS (earnings per share) for high levels of EBIT (earnings before interest and

taxes) because:

A) interest payments on the debt vary with EBIT levels.

B) interest payments on the debt stay fixed, leaving less income to be distributed

over less shares.

C) interest payments on the debt stay fixed, leaving more income to be

distributed over less shares.

D) interest payments on the debt stay fixed, leaving less income to be distributed

over more shares.

E) interest payments on the debt stay fixed, leaving more income to be

distributed over more shares.

Answer: C Page: 411

30. A levered (or leveraged) firm is a company that has:

A) is financed by common stock.

D) low variability of EPS

B) has some debt in the capital structure. E) none of the above.

C) has all equity in the capital structure.

Answer: B

31. The diversification effect of a portfolio of two stocks

A) increases as the correlation between the stocks declines.

B) increases as the correlation between the stocks rises.

C) decreases as the correlation between the stocks rises.

D) both b and c.

E) None of the above.

Correct answers: A and C

32. If the correlation between two stocks is 1, the returns:

A) generally move in the same direction

B) move perfectly opposite to one another

C) are unrelated to one another as it is <0

D) have standard deviations of equal size but opposite signs

E) none of the above.

Answer: B

33. For a diversified portfolio including a large number of stocks,:

A) the weighted average expected return goes to zero.

B) the weighted average of the betas goes to zero.

C) the weighted average of the unsystematic risk goes to zero.

D) the return of the portfolio goes to zero.

Answer: C

34. A growth stock portfolio and a value portfolio might be characterized

A) each by their P/E relative to the index P/E; high P/E for growth and lower for

value.

B) as earning a high rate of return for a growth security and a low rate of return

for value security irrespective of risk.

C) low unsystematic risk and high systematic risk respectively.

D) moderate systematic risk and zero systematic risk respectively.

E) none of the above.

Answer: A

35. When deciding what to do with spare cash (pay out as dividends or invest in new

projects), the firm's managers should implement an investment project only if:

A) the firm never pays a dividend.

B) the expected return on the project is greater than that of an asset of similar

risk.

C) the expected return on the project is less than that of an asset of similar risk.

D) the expected return on the project is equal to that of an asset of similar risk.

E) none of the above.

Answer: B Page: 353

36. What is its cost of equity of a firm if there are no taxes or other imperfections? The

firm has a debt-to-equity ratio of .60. Its cost of debt is 8%. Its overall cost of

capital is 12%.

A) 18% B) 14.4% C) 10%. D) 13.5% E) None of the above.

Answer: B

37. A risk factor is a variable that:

A) affects returns of many risky assets in a systematic fashion.

B) affects returns of many risky assets in an unsystematic fashion.

C) correlates with risky asset returns in a unsystematic fashion.

D) does not correlate with the returns of risky assets in an systematic fashion.

E) none of the above.

Answer: A

38. The beta of a portfolio of firm's debt and equity:

A) is equal to the sum of all the betas.

B) is equal to the sum of all the betas weighted by their market value weight.

C) is greater than the beta of each component.

D) is always less than zero.

E) can never be made up of debt and equity.

Answer: B

39. Comparing two otherwise equal firms, the beta of the common stock of a levered firm

is ____________ than the beta of the common stock of an unlevered firm.

A) equal to

D) greater

B) significantly less

E) none of the above

C) slightly less

Answer: D

40.Shareholders discount many corporate announcements because of their prior

expectations. If an announcement causes the price to change it will mostly be

driven by:

A) the expected part of the announcement.

B) market inefficiency.

C) the innovation or unexpected part of the announcement.

D) the systematic risk.

E) None of the above.

Answer: C

41. For a diversified portfolio including a large number of stocks,:

A) the weighted average expected return goes to zero.

B) the weighted average of the betas goes to zero.

C) the weighted average of the unsystematic risk goes to zero.

D) the return of the portfolio goes to zero.

E) the return on the portfolio equals the risk-free rate.

Answer: C

42. In normal market conditions if a security has a negative beta,:

A) the security always has a positive return.

B) the security has an expected return above the risk-free return.

C) the security has an expected return less than the risk-free rate.

D) the security has an expected return equal to the market portfolio.

E) both a & b are correct.

Answer: C

43 .A growth stock portfolio and a value portfolio might be characterized

A) each by their P/E relative to the index P/E; high P/E for growth and lower for

value.

B) as earning a high rate of return for a growth security and a low rate of return

for value security irrespective of risk.

C) low unsystematic risk and high systematic risk respectively.

D) moderate systematic risk and zero systematic risk respectively.

E) none of the above.

Answer: A

First Name_____________

Last Name_____________

Please use the sample at your own risk. Please read carefully the following questions

and problems. One more time, recall you are not supposed to use either tables or any

notes besides your two sheets of 8 1/2" by 11" paper. Please write on the scantron answers

to multiple choice questions. For written questions, be sure you show explicitly the

entire procedure used, step by step, in your way to arrive at the solutions to the assigned

problems. Write neatly. (Note that you might not need all the information given in some

questions in order to answer questions). Please hand in the exam paper.

In this sample, the topic for each question is shown in bold letters. In the real final, the

topic is not shown.

c

1. The hypothesis that market prices reflect all publicly-available information is called

efficiency in the:

a. Open form.

b. Strong form.

c. Semi-strong form.

d. Weak form.

e. Stable form.

EFFICIENT MARKETS

c

2. If markets are at least semi-strong form efficient, and a company announces new,

unexpected information regarding its future prospectsnamely, that sales will be much

lower than previously expectedwhat do you expect will happen in the stock market?

a. The value of a share will decline over an extended period of time as investors begin to

sell shares in the company.

b. The value of a share will fall below what is considered appropriate because of the

decreased demand for the shares, but eventually the price will rise to the correct level.

c. The value of a share will drop immediately to a price that reflects the value of the new

information.

d. The value of a share will rise over a long period of time as investors sell the stock.

e. The stock price will not change since this type of information has no impact in markets

that are semi-strong form efficient.

EFFICIENT MARKETS

C 3 If the stock market is semi-strong efficient but not efficient in the strong form,

which of the following statements is most correct?

a.

All stocks should have the same expected returns; however, they may have

different realized returns.

b.

In equilibrium, stocks and bonds should have the same expected returns.

c.

Investors can outperform the market if they have access to information

which has not yet been publicly revealed.

d.

If the stock market has been performing strongly over the past several

months, stock prices are more likely to decline than increase over the next

several months.

COST OF DEBT

b

4. The long-term debt of your firm is currently selling for 109% of its face value. The

issue matures in 12 years and pays an annual coupon of 7.5%. What is the (pretax) cost

of debt?

b.

c.

d.

e.

6.40%

7.50%

8.90%

9.30%

WACC

b

5. The market value of debt is $425 million and the total market value of the firm is $925

million. The cost of equity is 17%, the cost of debt is 10%, and the tax rate is 35%.

What is the WACC?

a. 11.01%

b. 12.18%

c. 13.78%

d. 14.17%

e. 15.64%

b 6 The CEO of 785.com is thinking about whether to invest in a project that will return a sure

7% with no risk. Risk free rate is 4.5%. What is the right discount rate in getting the NPV of the

project?

a. 7%

b. 4.5%

c. 6.75%

WACC

7.

You are comparing two firms. All you know about them is that the WACC of firm A is

12% and the WACC of firm B is 15%. Which of the following can you infer from this?

I. A has more systematic risk

II. A uses more debt

III. A and B are not in the same line of business

IV. A uses preferred stock but B does not

a. I and II only

b. I and III only

c. II and III only

d. I, II, and IV only

e. You cannot infer any of the above without additional information

8 Which of the following statement is NOT true for a portfolio made up of several

stocks?

a. The expected return = weighted average of each stocks expected return.

b. The portfolio standard deviation is >= the weighted average of each stocks

standard deviation.

c. The portfolio beta is the weighted average of each stocks beta

d. The portfolio standard deviation is <= the weighted average of each stocks

standard deviation.

Answer b

A 9

a. The slope of the security market line is measured by beta.

b. Two securities with the same stand-alone risk can have different betas.

c. Company-specific risk can be diversified away.

d. The market risk premium is affected by attitudes about risk.

e. Higher beta stocks have a higher required return.

GenLabs has been a hot stock the last few years, but is risky. The expected returns for GenLabs

are highly dependent on the state of the economy as follows:

State of Economy

Probability

GenLabs Returns

Depression

.05

-50%

Recession

.10

-15

Mild Slowdown

.20

5

Normal

.30

15%

Broad Expansion

.20

25

Strong Expansion

.15

40

10. The expected return on GenLabs is:

A) 3.3%

B) 8.5%

C) 12.5%

D) 20.5%

E) None of the above.

Answer: C Difficulty: Medium Page: 256

Rationale:

E(r) = .05(-.5) + .10(-.15) + .2(.05) + .3(.15) + .2(.25) + .15(.40) = .125 = 12.5%

A) .0207

B) .0428

C) .0643

D) .0733

E) None of the above.

Answer: B Difficulty: Medium Page: 256-257

Rationale:

.05(-.50 - .125)2 + .1(-.15 - .125)2 + .2(.05 - .125)2 + .3(.15 - .125)2 + .2(.25 - .125)2 +

.15(.40 - .125)2 = .0428

12. You have plotted the data for two securities over time on the same graph, ie., the month

return of each security for the last 5 years. If the pattern of the movements of the two

securities rose and fell as the other did, these two securities would have

A) no correlation at all.

B) a weak negative correlation.

C) a strong negative correlation.

D) a strong positive correlation.

E) one can not get any idea of the correlation from a graph.

Answer: D Difficulty: Easy Page: 260

A) the ability to diversify risk.

B) how an asset covaries with the market.

C) the actual return on an asset.

D) the standard of the assets' returns.

Answer: B Difficulty: Medium Page: 283

14.A stock with a beta of zero would be expected to have a rate of return equal to

A) the risk-free rate.

B) the market rate.

C) the prime rate.

D) the average AAA bond.

E) None of the above.

Answer: A Difficulty: Medium Page: 285

A) the expected return on a security is negatively and non-linearly related to the

security's beta.

B) the expected return on a security is negatively and linearly related to the security's

beta.

C) the expected return on a security is positively and linearly related to the security's

variance.

D) the expected return on a security is positively and non-linearly related to the

security's beta.

E) the expected return on a security is positively and linearly related to the security's

beta.

Answer: E Difficulty: Easy Page: 282

16. A portfolio contains two assets. The first asset comprises 40% of the portfolio and has a

beta of 1.2. The other asset has a beta of 1.5. The portfolio beta is

A) 1.35

B) 1.38

C) 1.42

D) 1.50

E) 1.55

Answer: B Difficulty: Medium Page: 287

Rationale:

p = .4(1.2)+.6(1.5)=1.38

17.The characteristic line is graphically depicted as

A) the plot of the relationship between beta and expected return.

B) the plot of the returns of the security against the beta.

C) the plot of the security returns against the market index returns.

D) the plot of the beta against the market index returns.

Answer: C

Options

5

A)

B)

C)

D)

larger than the strike price

equal or less than the strike price

none of the above

Answer C)

19. Suppose an investor buys one share of stock and a put option on the stock and

simultaneously sells a call option on the stock with the same exercise price. What will be

the value of his investment on the final exercise date?

A) Above the exercise price if the stock price rises and below the exercise price if it falls

B) Equal to the exercise price regardless of the stock price

C) Equal to zero regardless of the stock price

D) Below the exercise price if the stock price rises and above if it falls

E) None of the above

Answer: B

d

20. All else the same, the value of a call option decreases as the:

I. Underlying asset price decreases

II. Exercise price decreases

III. Volatility decreases

a. I only

b. II only

c. III only

d. I and III only

IMPLICIT OPTIONS

c

21. A ticket to a baseball game gives the holder the right, but not the obligation, to attend a

specified game. Thus, a baseball ticket is effectively a(n)

option on the

possession of a seat, which has an expiration date equal to

.

a. American call;

the day of the game

b. American call;

the end of the baseball season

c. European call;

the day of the game

d. European call;

the end of the baseball season

e. convertible bond;

the end of the baseball season

Use the following option quotes to answer questions #22 through #23.

Call

Put

Option

Strike

Exp.

Vol.

Last

Vol.

Cisco

15.00

Oct.

491

2.26

559

16.30

15.00

Nov.

259

2.90

154

16.30

17.50

Oct.

680

0.85

522

16.30

17.50

Nov.

142

1.33

40

16.30

17.50

Feb.

51

1.95

28

16.30

20.00

Oct.

828

0.30

915

16.30

20.00

Nov.

123

0.55

212

OPTION QUOTE

e

22. What is the market value per share of the November 15 call?

a. $1.30

b. $1.33

c. $1.95

d. $2.26

e. $2.90

OPTION QUOTE

c

23. Which of the options shown in the quote are in-the-money?

I. The October 15 call

II. The November 17.50 call

III. The October 15 put

IV. The November 20 put

a. I and II only

b. II and III only

c. I and IV only

d. III only

e. III and IV only

PROTECTIVE PUT

c

24. The purchase of stock and a put option on the stock to limit the downside risk

associated with the stock is a strategy called the

.

a. put-call parity relation

b. covered call

c. protective put

d. straddle

Last

0.25

1.00

1.60

2.31

3.77

4.05

4.67

e.

strangle

PUT-CALL PARITY

c

25. An European put option with exercise price $50 and 6 months to expiration sells for

$1.00. The continuously-compounded risk-free rate is 8% annually (so that

PV(k)=$50*exp(-0.08*0.5)= $48.04), and the stock sells for $56. How much must a

call option sell for with the same exercise price and expiration?

a. $ 6.00

b. $ 7.51

c. $ 8.96

d. $ 9.65

e. $10.84

Written questions

1.

The Jackson Company has just paid a dividend of $3.00 per share (D0) on its

common stock, and it expects this dividend to grow by 10 percent per year,

indefinitely. The firm has a beta of 1.50; the risk-free rate is 10 percent; and the

expected return on the market is 14 percent. (3 points)

How much should an investor be willing to pay for this stock today?

Rs = RF + (RM RF) = 10% + 1.5 x (14% - 10%) = .10 +

10% + 1.5(4%) = 16%.

P0 =

$3.00(1.10)

0.16 - 0.10

1.5 x 0.04

= $55.00.

2. Assume that the bond A, B, and C issued by US government have no default risk. In

addition,

Bond A pays coupon rate of 6% and matures in 10 years. Price=$1000

Bond B pays coupon rate of 12% and matures in 10 years. Price=$1100

Bond C pays coupon rate of 9% and matures in 10 years. Price=$1060

Describe an arbitrage strategy and your profit. (2 points)

Buy (go long) 1 share of Bond A and 1 share of bond B, go short 2 shares of bond C.

Because you are using the proceeds from going short of 2 bond c to buy one bond A

and one bond B, you can make a profit of $20 immediately.

In the next 10 years, use the cash inflows from Bond A and Bond B to pay off your

obligation under Bond C.

Practice questions from chapters 10-12 (with a few bonus questions from chapter 13).

1. The excess return required on a risky asset over that earned on a risk-free asset is called (a):

A) Risk premium.

B) Return premium.

C) Excess return.

D) Average return.

E) Variance.

Answer: A

2. An efficient capital market is one in which:

A) Brokerage commissions are zero.

B) Taxes are irrelevant.

C) Securities always offer a positive rate of return to investors.

D) Security prices are guaranteed (by the Securities and Exchange Commission) to be fair.

E) Security prices reflect available information.

Answer: E

3. The hypothesis that market prices reflect all available, public and private, information is called

efficiency in the:

A) Open form.

B) Strong form.

C) Semi-strong form.

D) Weak form.

E) Stable form.

Answer: B

4. The hypothesis that market prices reflect all publicly-available information is called efficiency in

the:

A) Open form.

B) Strong form.

C) Semi-strong form.

D) Weak form.

E) Stable form.

Answer: C

5. The hypothesis that market prices reflect all historical information is called efficiency in the:

A) Open form.

B) Strong form.

C) Semi-strong form.

D) Weak form.

E) Stable form.

Answer: D

6. Over the past 76 years, which of the following investments has provided the largest average

return?

A) Small company stocks

B) Common stocks

C) Treasury bills

D) Treasury bonds

E) Corporate bonds

Answer: A

7. Over the past 76 years, which of the following investments has been the least risky?

A) Small company stocks

B) Common stocks

C) Treasury bills

D) Treasury bonds

E) Corporate bonds

Answer: C

8. You track the liquidity of companies and find that you can consistently earn unusually high

returns by purchasing the shares of firms whose stock price falls below the cash value per share

as indicated on the balance sheet. Which of the following describes this strategy?

A) This would not be a violation of market efficiency.

B) This would be a violation of weak form efficiency.

C) This would be a violation of semi-strong form efficiency.

D) This would be a violation of strong form efficiency.

E) This would be a violation of all forms of market efficiency.

Answer: C

9. Last year you purchased 1,000 shares of Sun Microsystems stock for $15 per share. According to

today's quote in The Wall Street Journal, the stock is currently selling for $3 per share. The stock

pays no dividends. Your return on this investment is comprised of _____________.

A) retained earnings and dividend yields

B) an income return and a capital gains return

C) a real return only

D) a capital gains return only

E) there is no return, since you lost money on this investment

Answer: D

10. Which of the following is generally considered to represent the risk-free return?

A) Common stocks

B) Small stocks

C) Long-term government bonds

D) Long-term corporate bonds

E) Treasury bills

Answer: E

11. You purchased a bond for $870 one year ago. Today, you receive your only interest payment for

the year of $70. The bond can currently be sold for $925. What is your total percentage return on

investment? Ignore tax effects.

A) 6.3%

B) 8.1%

C) 14.4%

D) 16.5%

E) 20.8%

Answer: C

12. You purchased 500 shares of preferred stock on January 1, 2002, for $85 per share. The stock

pays an annual dividend of $12 per share. On December 31, 2002, the market price is $91 per

share. What is your total dollar return for the year?

A) $ 3,000

B) $ 4,500

C) $ 6,000

D) $ 9,000

E) $12,000

Answer: D

Response: 500 ($91 - 85 + 12) = $9,000

13. You purchased a bond on January 1, 2002, for $1,065. The bond has a $1,000 face value, a 10%

annual coupon, and can be sold for $975 on December 31, 2002. What is your percentage return

on investment for the year?

A) 4.1%

B) 0.9%

C) 4.6%

D) 8.3%

E) 12.5%

Answer: B

Response: R = [($975 - 1,065) / 1,065] + (100 / 1,065) = .0094

14. You purchased 500 shares of preferred stock on January 1, 2002, for $50 per share. The stock

pays an annual dividend of $8 per share. On December 31, 2002, the market price is $54 per

share. What is your percentage return on investment for the year?

A) 4%

B) 8%

C) 16%

D) 20%

E) 24%

Answer: E

Response: R = [($54 - 50) / 50] + (8 / 50) = .24

You purchase 800 shares of stock at a price of $20 per share. One year later, the shares are selling for $23

per share. In addition, a dividend of $2 per share is paid at the end of each year.

A) $1,600

B) $2,400

C) $4,000

D) $6,800

E) $8,000

Answer: C

Response: 800 ($23 - 20 + 2) = $4,000

16. What is the capital gains yield for the investment?

A) 8.5%

B) 10.0%

C) 11.5%

D) 13.0%

E) 15.0%

Answer: E

Response: CGY = ($23 - 20) / 20 = .15

17. What is the dividend yield for the investment?

A) 2.5%

B) 7.5%

C) 10.0%

D) 15.0%

Answer: C

Response: DY = $2 / 20 = .10

18. What is the total percentage return for the investment?

A) 5%

B) 10%

C) 15%

D) 20%

E) 25%

Answer: E

Response: R = [($23 - 20) / 20] + (2 / 20) = .25

Chapter 11 questions begin here

1. A portfolio is ___________________________.

A) a group of assets, such as stocks and bonds, held as a collective unit by an investor

B) the expected return on a risky asset

C) the expected return on a collection of risky assets

D) the variance of returns for a risky asset

E) the standard deviation of returns for a collection of risky assets

Answer: A

2. The percentage of a portfolio's total value invested in a particular asset is called that asset's:

A) Portfolio return.

B) Portfolio weight.

C) Portfolio risk.

D) Rate of return.

E) Investment value.

Answer: B

3. Risk that affects a large number of assets, each to a greater or lesser degree, is called:

A) Idiosyncratic risk.

B) Diversifiable risk.

C) Systematic risk.

D) Asset-specific risk.

E) Total risk.

Answer: C

4. Risk that affects at most a small number of assets is called:

A) Portfolio risk.

B) Undiversifiable risk.

C) Market risk.

D) Unsystematic risk.

E) Total risk.

Answer: D

5. The principle of diversification tells us that:

A) Concentrating an investment in two or three large stocks will eliminate all of your risk.

B) Concentrating an investment in two or three large stocks will reduce your overall risk.

C) Spreading an investment across many diverse assets cannot (in an efficient market) eliminate

any risk.

D) Spreading an investment across many diverse assets will eliminate all of the risk.

E) Spreading an investment across many diverse assets will eliminate some of the risk.

Answer: E

6. The ___________________ tells us that the expected return on a risky asset depends only on that

asset's systematic risk.

A) Efficient Markets Hypothesis (EMH)

B) systematic risk principle

C) Open Markets Theorem

D) Law of One Price

E) principle of diversification

Answer: B

7. The amount of systematic risk present in a particular risky asset, relative to the systematic risk

present in an average risky asset, is called the particular asset's:

A) Beta coefficient.

B) Reward to risk ratio.

C) Law of One Price.

D) Diversifiable risk.

E) Treynor index.

Answer: A

8. The linear relation between an asset's expected return and its beta coefficient is the:

A) Reward to risk ratio.

B) Portfolio weight.

C) Portfolio risk.

D) Security market line.

E) Market risk premium.

Answer: D

9. Diversification works because:

A) Unsystematic risk exists.

B) Forming stocks into portfolios reduces the standard deviation of returns for each stock.

C) Firm-specific risk can be never be reduced.

D) Stocks earn higher returns than bonds.

E) Portfolios have higher returns than individual assets.

Answer: A

10. A security has an unexpected negative news announcement specific to that security. Most likely,

the ______________________________.

A) security's required return on investment will increase.

B) security's required return on investment will remain unchanged.

D) market risk premium will increase.

E) security's market price will remain unchanged.

Answer: A

11. New information regarding a security, when received by the market, leads to a(n):

A) Unexpected return.

B) Expected return.

C) Actual return.

D) Systematic return.

E) Non-diversifiable return.

Answer: A

12. You own 50 shares of stock A, which has a price of $12 per share, and 100 shares of stock B,

which has a price of $3 per share. What is the portfolio weight for stock A in your portfolio?

A) 25%

B) 33%

C) 50%

D) 67%

E) 75%

Answer: D

Response: 50($12) + 100(3) = $900; wA = $600 / 900 = .67

13. What is the expected return for the following stock?

State

Average

Recession

Depression

Probability

.50

.35

.15

Return

.25

.05

.35

A) .05

B) .08

C) .09

D) .10

E) .12

Answer: C

Response: 50(.25) + .35(.05) + .15(-.35) = .09

14. What is the risk premium for the following returns if the risk-free rate is 4%?

State

Boom

Good

Recession

Depression

A)

B)

C)

D)

E)

0.3325

0.1525

0.0525

0.1825

0.2225

Probability

.20

.55

.15

.10

Return

.75

.25

.10

.50

Answer: D

Response: .20(.75) + .55(.25) + .15(-10)+ .10(-50) = .2225; RP = .2225 .04 = .1825

15. What is the expected portfolio return given the following information:

Asset

A

B

C

D

Portfolio weight

.35

.15

.25

.25

Return

20%

35%

6%

12%

A) 6.75%

B) 9.50%

C) 16.75%

D) 18.25%

E) 21.50%

Answer: C

Response: .35(.20) + .15(.35) + .25(.06) + .25(.12) = .1675

16. What is the expected return on asset A if it has a beta of 0.6, the expected market return is 15%,

and the risk-free rate is 6%?

A) 5.4%

B) 9.6%

C) 11.4%

D) 15.0%

Answer: C

Response: 6 + .6(15 - 6) = 11.4%

Chapter 12 questions begin here

1. The opportunity cost associated with the firm's capital investment in a project is called its:

A) Cost of capital.

B) Beta coefficient.

C) Capital gains yield.

D) Sunk cost.

E) Internal rate of return.

Answer: A

2. The return that shareholders require on their investment in the firm is called the:

A) Dividend yield.

B) Cost of equity.

C) Capital gains yield.

D) Cost of capital.

E) Income return.

Answer: B

3. The return that lenders require on their loaned funds to the firm is called the:

A) Coupon rate.

B) Current yield.

C) Cost of debt.

D) Capital gains yield.

E) Cost of capital.

Answer: C

4. The weighted average of the firm's costs of equity, preferred stock, and aftertax debt is the:

A) Reward to risk ratio for the firm.

B) Expected capital gains yield for the stock.

C) Expected capital gains yield for the firm.

D) Portfolio beta for the firm.

E) Weighted average cost of capital (WACC).

Answer: E

5. All of the following could be considered advantages in assessing the cost of preferred stock

compared to the cost of common stock EXCEPT:

A) Preferred stock generally carries with it a fixed dividend payment.

B) Preferred stock is often rated for default risk.

C) The cost of preferred stock is simply equal to its dividend yield.

D) The cost of preferred stock can be calculated as a perpetuity based on the fixed dividend

payment and the present stock price.

E) Unlike common stock, preferred stock requires no assumptions be made about future cash

flows.

Answer: E

6. Which of the following, among other things, is needed to calculate the weighted average cost of

capital for a non-profit corporation?

A) The par value of bonds outstanding.

B) The bond rating of the firm's outstanding debt issues.

C) The corporate tax rate.

D) The number of preferred shares outstanding.

E) The operating cash flow for the most recent reporting period.

Answer: D

7. All else the same, a higher corporate tax rate _____________________.

A) will decrease the WACC of a firm with some debt in its capital structure

B) will increase the WACC of a firm with some debt in its capital structure

C) will not affect the WACC of a firm with some debt in its capital structure

D) will decrease the WACC of a firm with no debt in its capital structure

E) will change the WACC of a firm with some debt in its capital structure, but the direction is

unclear.

Answer: A

8. To estimate the cost of equity for a firm, which of the following variables would NOT be needed?

A) The current dividend payment.

B) The risk-free interest rate.

C) The debt/equity ratio.

D) The beta coefficient.

E) The market price of the stock.

Answer: C

9. A firm is expected to pay a dividend of $3.50 per share in one year. This dividend, along with the

firm's earnings, is expected to grow at a rate of 7% forever. If the current market price for a share

is $67, what is the cost of equity?

A) 7.00%

B) 12.22%

C) 15.64%

D) 14.00%

E) 13.46%

Answer: B

Response: ($3.50 / 67) + .07 = .1222

10. The long-term debt of your firm is currently selling for 109% of its face value. The issue matures

in 12 years and pays an annual coupon of 7.5%. What is the cost of debt?

A) 5.60%

B) 6.40%

C) 7.50%

D) 8.90%

E) 9.30%

Answer: B

Response: $1,090 = $75{[1 - 1/(1 + YTM)12] / YTM} + 1,000 / (1 + YTM)12; YTM = 6.40%

11. A company's preferred stock pays an annual dividend of $7.00 per share. When issued, the shares

sold for their par value of $100 per share. What is the cost of preferred stock if the current price is

$120 per share?

A) 5.8%

B) 7.0%

C) 8.1%

D) 9.6%

E) 12.0%

Answer: A

Response: $7 / 120 = .058

12. Suppose that your firm has a cost of equity of 18% and a cost of debt of 8%. If the target

debt/equity ratio is 0.60, and the tax rate is 35%, what is the firm's weighted average cost of

capital (WACC)?

A) 7.4%

B) 9.9%

C) 11.8%

D) 13.2%

E) 14.3%

Answer: D

Response: .18(10/16) + .08(6/16)(1-35) = .132

13. Suppose a firm has 19 million shares of common stock outstanding with a par value of $1.00 per

share. The current market price per share is $18.35. The firm has outstanding debt with a par

value of $114.5 million selling at 96% of par. What capital structure weight would you use for

debt when calculating the firm's WACC?

A) 0.15

B) 0.24

C) 0.54

D) 0.76

E) 0.96

Answer: B

Response: V = 19M($18.35) + 114,500($960) = $458,570,000; D/V = $109.92M / 458.57M =

.240

14. A common stock issue is currently selling for $31 per share. You expect the next dividend to be

$1.40 per share. If the firm has a dividend growth rate of 5% that is expected to remain constant

indefinitely, what is the firm's cost of equity?

A) 9.5%

B) 11.3%

C) 13.8%

D) 14.2%

E) 15.1%

Answer: A

Response: ($1.40/31) + .05 = .0952

15. Given the following information, what is the average annual dividend growth rate?

Dividend

$1.80

$1.90

$2.15

$2.28

$2.49

$2.75

A) 4.9%

B) 6.2%

C) 8.8%

D) 9.7%

E) 10.3%

Answer: C

Response: ($.10/1.80 + .25/1.90 + .13/2.15 + .21/2.28 + .26/2.49) / 5 = .0888

16. Treasury bills currently have a return of 2.5% and the market risk premium is 7%. If a firm has a

beta of 1.4, what is its cost of equity?

A) 8.1%

B) 9.9%

C) 10.8%

D) 12.3%

E) 14.4%

Answer: D

Response: 2.5 + 1.4(7) = 12.3%

17. Your firm sold a 25-year bond at par 19 years ago. The bond pays an 6% annual coupon, has a

$1,000 face value, and currently sells for $825. What is the firm's cost of debt?

A) 6.0%

B) 8.2%

C) 9.5%

D) 10.0%

E) 11.3%

Answer: D

Response: $825 = $60{[1 - 1/(1 + YTM)6] / YTM} + 1,000 / (1 + YTM)6; YTM = 10.02%

18. A company has preferred stock outstanding which pays a dividend of $6 per share a year. The

current stock price is $75 per share. What is the cost of preferred stock?

A) 6%

B) 7%

C) 10%

D) 9%

E) 8%

Answer: E

Response: $6 / 75 = .08

19. A firm sold a 10-year bond issue 3 years ago. The bond has a 6.45% annual coupon and a $1,000

face value. If the current market price of the bond is $951.64 and the tax rate is 35%, what is the

aftertax cost of debt?

A) 3.50%

B) 5.99%

C) 6.45%

D) 7.36%

E) 4.78%

Answer: E

Response:

$951.64 = $64.50{[1 - 1/(1 + YTM)7] / YTM} + 1,000 / (1 + YTM) 7; YTM = 7.359%

AT = 7.359(1-.35) = 4.783%

20. Given the following information, what is the firm's weighted average cost of capital? Market

value of equity = $30 million; market value of debt = $20 million; cost of equity = 15%; cost of

debt = 9%; equity beta = 1.4; tax rate = 35%.

A) 11.34%

B) 12.60%

C) 12.97%

D) 13.32%

E) 14.08%

Answer: A

Response: 15($30M/50M) + 9(20M/50M)(1-.35) = 11.34%

Chapter 13 questions begin here

1. The equity risk derived from the firm's operating activities is called ___________ risk.

A) market

B) systematic

C) extrinsic

D) business

E) financial

Answer: D

2. The equity risk derived from the firm's capital structure policy is called ___________ risk.

A) market

B) systematic

C) extrinsic

D) business

E) financial

Answer: E

3. The tax savings of the firm derived from the deductibility of interest expense is called the:

A) Interest tax shield.

B) Depreciable basis.

C) Financing umbrella.

D) Current yield.

E) Tax-loss carryforward savings.

Answer: A

4. The financial leverage of a firm will ______________________ .

I. decrease as the debt/equity ratio increases

II. decrease as the firm's retained earnings account grows

III. decrease if the firm has negative net income

A) I only

B) II only

C) III only

D) I and II only

E) II and III only

Answer: B

5. The optimal capital structure is the mixture of debt and equity which:

I. Maximizes the value of the firm.

II. Maximizes the firm's weighted average cost of capital.

III. Maximizes the market price of the firm's bonds.

A) I only

B) III only

C) I and II only

D) I and III only

E) I, II and III

Answer: A

6. Above the breakeven EBIT, increased financial leverage will __________ EPS, all else the same.

Assume there are no taxes.

A) increase

B) decrease

C) not affect

D) either increase or decrease

E) increase EBIT but decrease

Answer: A

7. ___________ arises from decisions that affect the left-hand side of the balance sheet,

while___________ arises from decisions that affect the right-hand side of the balance sheet.

A) Systematic risk; financial risk

B) Systematic risk; unsystematic risk

C) Unsystematic risk; systematic risk

D) Business risk; financial risk

E) Business risk; diversifiable risk

Answer: D

A) The financial risk of a firm decreases when it takes on a risky project.

B) The financial risk of a firm increases when it takes on more equity.

C) The business risk of a firm increases when it takes on a risky project.

D) The business risk of a firm increases when it takes on more debt.

E) The higher the business risk for a firm, the higher the financial risk as well.

Answer: C

CHAPTER 13

Return, Risk, and the Security Market Line

I.

DEFINITIONS

PORTFOLIOS

a

1. A portfolio is:

a. a group of assets, such as stocks and bonds, held as a collective unit by an investor.

b. the expected return on a risky asset.

c. the expected return on a collection of risky assets.

d. the variance of returns for a risky asset.

e. the standard deviation of returns for a collection of risky assets.

PORTFOLIO WEIGHTS

b

2. The percentage of a portfolios total value invested in a particular asset is called that

assets:

a. portfolio return.

b. portfolio weight.

c. portfolio risk.

d. rate of return.

e. investment value.

SYSTEMATIC RISK

c

3. Risk that affects a large number of assets, each to a greater or lesser degree, is called

_____ risk.

a. idiosyncratic

b. diversifiable

c. systematic

d. asset-specific

e. total

UNSYSTEMATIC RISK

d

4. Risk that affects at most a small number of assets is called _____ risk.

a. portfolio

b. undiversifiable

c. market

d. unsystematic

e. total

PRINCIPLE OF DIVERSIFICATION

e

5. The principle of diversification tells us that:

a. concentrating an investment in two or three large stocks will eliminate all of your risk.

b. concentrating an investment in three companies all within the same industry will

greatly reduce your overall risk.

c. spreading an investment across five diverse companies will not lower your overall risk

at all.

d. spreading an investment across many diverse assets will eliminate all of the risk.

e. spreading an investment across many diverse assets will eliminate some of the risk.

CHAPTER 13

SYSTEMATIC RISK PRINCIPLE

b

6. The _____ tells us that the expected return on a risky asset depends only on that assets

nondiversifiable risk.

a. Efficient Markets Hypothesis (EMH)

b. systematic risk principle

c. Open Markets Theorem

d. Law of One Price

e. principle of diversification

BETA COEFFICIENT

a

7. The amount of systematic risk present in a particular risky asset, relative to the

systematic risk present in an average risky asset, is called the particular assets:

a. beta coefficient.

b. reward-to-risk ratio.

c. total risk.

d. diversifiable risk.

e. Treynor index.

REWARD-TO-RISK RATIO

c

8. A particular risky assets risk premium, measured relative to its beta coefficient, is its:

a. diversifiable risk.

b. systematic risk.

c. reward-to-risk ratio.

d. security market line.

e. market risk premium.

SECURITY MARKET LINE

d

9. The linear relation between an assets expected return and its beta coefficient is the:

a. reward-to-risk ratio.

b. portfolio weight.

c. portfolio risk.

d. security market line.

e. market risk premium.

MARKET RISK PREMIUM

e

10. The slope of an assets security market line is the:

a. reward-to-risk ratio.

b. portfolio weight.

c. beta coefficient.

d. risk-free interest rate.

e. market risk premium.

CHAPTER 13

II. CONCEPTS

EXPECTED RETURN

e

11. You are considering purchasing stock S. This stock has an expected return of 8 percent

if the economy booms and 3 percent if the economy goes into a recessionary period.

The overall expected rate of return on this stock will:

a. be equal to one-half of 8 percent if there is a 50 percent chance of an economic boom.

b. vary inversely with the growth of the economy.

c. increase as the probability of a recession increases.

d. be equal to 75 percent of 8 percent if there is a 75 percent chance of a boom economy.

e. increase as the probability of a boom economy increases.

EXPECTED RETURN

c

12. Which one of the following statements is correct concerning the expected rate of return

on an individual stock given various states of the economy?

a. The expected return is a geometric average where the probabilities of the economic

states are used as the exponential powers.

b. The expected return is an arithmetic average of the individual returns for each state of

the economy.

c. The expected return is a weighted average where the probabilities of the economic

states are used as the weights.

d. The expected return is equal to the summation of the values computed by dividing the

expected return for each economic state by the probability of the state.

e. As long as the total probabilities of the economic states equal 100 percent, then the

expected return on the stock is a geometric average of the expected returns for each

economic state.

EXPECTED RETURN

d

13. The expected return on a stock that is computed using economic probabilities is:

a. guaranteed to equal the actual average return on the stock for the next five years.

b. guaranteed to be the minimal rate of return on the stock over the next two years.

c. guaranteed to equal the actual return for the immediate twelve month period.

d. a mathematical expectation based on a weighted average and not an actual anticipated

outcome.

e. the actual return you should anticipate as long as the economic forecast remains

constant.

DIVERSIFIABLE RISKS

b

14. Which one of the following is an example of diversifiable risk?

a. the price of electricity just increased

b. the employees of Textile, Inc. just voted to go on strike

c. the government just imposed new safety standards for all employees

d. the government just lowered corporate income tax rates

e. the cost of group health insurance just increased nationwide

CHAPTER 13

DIVERSIFIABLE RISKS

a

15. Which of the following statements are correct concerning diversifiable risks?

I.

Diversifiable risks can be essentially eliminated by investing in several unrelated

securities.

II. The market rewards investors for diversifiable risk by paying a risk premium.

III. Diversifiable risks are generally associated with an individual firm or industry.

IV. Beta measures diversifiable risk.

a. I and III only

b. II and IV only

c. I and IV only

d. II and III only

e. I, II, and III only

NONDIVERSIFIABLE RISKS

c

16. Which of the following are examples of nondiversifiable risks?

I.

the inflation rate spikes nationwide

II. an unexpected terrorist event occurs

III. the price of lumber suddenly spikes

IV. taxes are increased on hotels

a. I and III only

b. II and IV only

c. I and II only

d. II and III only

e. I, II, and IV only

NONDIVERSIFIABLE RISKS

d

17. Which of the following statements concerning nondiversifiable risk are correct?

I.

Nondiversifiable risk is measured by standard deviation.

II. Systematic risk is another name for nondiversifiable risk.

III. The risk premium increases as the nondiversifiable risk increases.

IV. Nondiversifiable risks are those risks you can not avoid if you are invested in the

financial markets.

a. I and III only

b. II and IV only

c. I, II, and III only

d. II, III, and IV only

e. I, II, III, and IV

NONDIVERSIFIABLE RISKS

b

18. Which one of the following is an example of a nondiversifiable risk?

a. a well respected president of a firm suddenly resigns

b. a well respected chairman of the Federal Reserve suddenly resigns

c. a key employee of a firm suddenly resigns and accepts employment with a key

competitor

d. a well managed firm reduces its work force and automates several jobs

e. a poorly managed firm suddenly goes out of business due to lack of sales

CHAPTER 13

RISK PREMIUM

a

19. The risk premium for an individual security is computed by:

a. multiplying the securitys beta by the market risk premium.

b. multiplying the securitys beta by the risk-free rate of return.

c. adding the risk-free rate to the securitys expected return.

d. dividing the market risk premium by the quantity (1 beta).

e. dividing the market risk premium by the beta of the security.

STANDARD DEVIATION

a

20. Standard deviation measures _____ risk.

a. total

b. nondiversifiable

c. unsystematic

d. systematic

e. economic

PORTFOLIO WEIGHT

c

21. When computing the expected return on a portfolio of stocks the portfolio weights are

based on the:

a. number of shares owned in each stock.

b. price per share of each stock.

c. market value of the total shares held in each stock.

d. original amount invested in each stock.

e. cost per share of each stock held.

PORTFOLIO EXPECTED RETURN

e

22. The portfolio expected return considers which of the following factors?

I.

the amount of money currently invested in each individual security

II. various levels of economic activity

III. the performance of each stock given various economic scenarios

IV. the probability of various states of the economy

a. I and III only

b. II and IV only

c. I, III, and IV ony

d. II, III, and IV only

e. I, II, III, and IV

PORTFOLIO EXPECTED RETURN

d

23. The expected return on a portfolio:

a. can be greater than the expected return on the best performing security in the portfolio.

b. can be less than the expected return on the worst performing security in the portfolio.

c. is independent of the performance of the overall economy.

d. is limited by the returns on the individual securities within the portfolio.

e. is an arithmetic average of the returns of the individual securities when the weights of

those securities are unequal.

CHAPTER 13

PORTFOLIO VARIANCE

b

24. If a stock portfolio is well diversified, then the portfolio variance:

a. will equal the variance of the most volatile stock in the portfolio.

b. may be less than the variance of the least risky stock in the portfolio.

c. must be equal to or greater than the variance of the least risky stock in the portfolio.

d. will be a weighted average of the variances of the individual securities in the portfolio.

e. will be an arithmetic average of the variance of the individual securities in the

portfolio.

PORTFOLIO STANDARD DEVIATION

b

25. Which one of the following statements is correct concerning the standard deviation of

a portfolio?

a. The greater the diversification of a portfolio, the greater the standard deviation of that

portfolio.

b. The standard deviation of a portfolio can often be lowered by changing the weights of

the securities in the portfolio.

c. Standard deviation is used to determine the amount of risk premium that should apply

to a portfolio.

d. Standard deviation measures only the systematic risk of a portfolio.

e. The standard deviation of a portfolio is equal to a weighted average of the standard

deviations of the individual securities held within the portfolio.

PORTFOLIO STANDARD DEVIATION

c

26. The standard deviation of a portfolio will tend to increase when:

a. a risky asset in the portfolio is replaced with U.S. Treasury bills.

b. one of two stocks related to the airline industry is replaced with a third stock that is

unrelated to the airline industry.

c. the portfolio concentration in a single cyclical industry increases.

d. the weights of the various diverse securities become more evenly distributed.

e. short-term bonds are replaced with long-term bonds.

EXPECTED AND UNEXPECTED RETURNS

c

27. Which one of the following events is considered part of the expected return on Fido

stock?

a. The president of Fido suddenly announced that the firm is going to cut production

effective immediately.

b. The government just announced a tax cut which will directly impact the sales of Fido.

c. The management of Fido announced their ten-year plan for expansion five years ago.

d. The price of Fido stock suddenly dropped due to rumors concerning company fraud.

e. Fido just won a major government contract which they had not anticipated winning.

EXPECTED AND UNEXPECTED RETURNS

e

28. Which one of the following statements is correct?

a. The unexpected return is always negative.

b. The expected return minus the unexpected return is equal to the total return.

c. Over time, the average return is equal to the unexpected return.

d. The expected return includes the surprise portion of news announcements.

e. Over time, the average unexpected return will be zero.

CHAPTER 13

TOTAL RISK

d

29. _____ measures total risk.

a. The mean

b. Beta

c. The geometric average

d. The standard deviation

e. The arithmetic average

SYSTEMATIC RISK

b

30. Systematic risk is measured by:

a. the mean.

b. beta.

c. the geometric average.

d. the standard deviation.

e. the arithmetic average.

SYSTEMATIC RISK

c

31. Which one of the following is an example of systematic risk?

a. the price of lumber declines sharply

b. airline pilots go on strike

c. the Federal Reserve increases interest rates

d. a hurricane hits a tourist destination

e. people become diet conscious and avoid fast food restautants

SYSTEMATIC RISK

a

32. The systematic risk of the market is measured by:

a. a beta of 1.0.

b. a beta of 0.0.

c. a standard deviation of 1.0.

d. a standard deviation of 0.0.

e. a variance of 1.0.

SYSTEMATIC RISK

c

33. Which one of the following portfolios should have the most systematic risk?

a. 50 percent invested in U.S. Treasury bills and 50 percent in a market index mutual

fund

b. 20 percent invested in U.S. Treasury bills and 80 percent invested in a stock with a

beta of .80

c. 10 percent invested in a stock with a beta of 1.0 and 90 percent invested in a stock with

a beta of 1.40

d. 100 percent invested in a mutual fund which mimics the overall market

e. 100 percent invested in U.S. Treasury bills

CHAPTER 13

SYSTEMATIC RISK

e

34. Which of the following risks are relevant to a well-diversified investor?

I.

systematic risk

II. unsystematic risk

III. market risk

IV. nondiversifiable risk

a. I and III only

b. II and IV only

c. II, III, and IV only

d. I, II, and IV only

e. I, III, and IV only

UNSYSTEMATIC RISK

a

35. Unsystematic risk:

a. can be effectively eliminated through portfolio diversification.

b. is compensated for by the risk premium.

c. is measured by beta.

d. cannot be avoided if you wish to participate in the financial markets.

e. is related to the overall economy.

UNSYSTEMATIC RISK

c

36. Which one of the following is an example of unsystematic risk?

a. the inflation rate increases unexpectedly

b. the federal government lowers income taxes

c. an oil tanker runs aground and spills its cargo

d. interest rates decline by one-half of one percent

e. the GDP rises by 2 percent more than anticipated

UNSYSTEMATIC RISK

e

37. Which of the following actions help eliminate unsystematic risk in a portfolio?

I.

spreading the retail industry portion of a portfolio over five separate stocks

II. combining stocks with bonds in a portfolio

III. adding some international securities into a portfolio of U.S. stocks

IV. adding some U.S. Treasury bills to a risky portfolio

a. I and III only

b. I, II, and IV only

c. I, III, and IV only

d. II, III, and IV only

e. I, II, III, and IV

CHAPTER 13

UNSYSTEMATIC RISK

a

38. Which of the following statements is (are) correct concerning unsystematic risk?

I.

Assuming unsystematic risk is rewarded by the marketplace.

II. Eliminating unsystematic risk is the responsibility of the individual investor.

III. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk.

IV. The Capital Asset Pricing Model specifically rewards investors for assuming

unsystematic risk via the application of beta in the formula.

a. II only

b. III and IV only

c. I, III and IV only

d. II and III only

e. I and III only

DIVERSIFICATION

c

39. The primary purpose of portfolio diversification is to:

a. increase returns and risks.

b. eliminate all risks.

c. eliminate asset-specific risk.

d. eliminate systematic risk.

e. lower both returns and risks.

DIVERSIFICATION

e

40. Which one of the following would tend to indicate that a portfolio is being effectively

diversified?

a. an increase in the portfolio beta

b. a decrease in the portfolio beta

c. an increase in the portfolio rate of return

d. an increase in the portfolio standard deviation

e. a decrease in the portfolio standard deviation

DIVERSIFICATION

c

41. The majority of the benefits from portfolio diversification can generally be achieved

with just _____ diverse securities.

a. 3

b. 6

c. 30

d. 50

e. 75

SYSTEMATIC RISK PRINCIPLE

c

42. The systematic risk principle implies that the _____ an asset depends only on that

assets systematic risk.

a. variance of the returns on

b. standard deviation of the returns on

c. expected return on

d. total risk assumed by owning

e. diversification benefits of

CHAPTER 13

SYSTEMATIC RISK PRINCIPLE

e

43. Which one of the following measures is relevant to the systematic risk principle?

a. variance

b. alpha

c. standard deviation

d. theta

e. beta

PORTFOLIO BETA

b

44. Which of the following statements are correct concerning the beta of a portfolio?

I.

Portfolio betas will always be greater than 1.0.

II. A portfolio beta is a weighted average of the b etas of the individual securities

contained in the portfolio.

III. A portfolio of U.S. Treasury bills will have a beta equal to minus one.

IV. If the portfolio beta is greater than one then the portfolio has more risk than the overall

market.

a. I and III only

b. II and IV only

c. I, II, and III only

d. II, III, and IV only

e. I, II, and IV only

PORTFOLIO BETA

b

45. Which of the following variables do you need to know to estimate the amount of

additional reward you will receive for purchasing a risky asset instead of a risk-free

asset?

I.

standard deviation

II. beta

III. risk-free rate of return

IV. market risk premium

a. I and III only

b. II and IV only

c. I, III, and IV only

d. II, III, and IV only

e. I, II, III, and IV

SECURITY MARKET LINE (SML)

c

46. A security that is fairly priced will have a return that lies _____ the Security Market

Line.

a. below

b. on or below

c. on

d. on or above

e. above

CHAPTER 13

SECURITY MARKET LINE (SML)

a

47. The intercept point of the security market line is the rate of return which corresponds

to:

a. the risk-free rate of return.

b. the market rate of return.

c. a value of zero.

d. a value of 1.0.

e. the beta of the market.

SECURITY MARKET LINE (SML)

c

48. A stock with an actual return that lies above the security market line:

a. has more systematic risk than the overall market.

b. has more risk than warranted based on the realized rate of return.

c. has yielded a higher return than expected for the level of risk assumed.

d. has less systematic risk than the overall market.

e. has yielded a return equivalent to the level of risk assumed.

SECURITY MARKET LINE (SML)

c

49. The market rate of return is 12 percent and the risk-free rate of return is 4 percent. A

stock that has 5 percent more risk than the market has an actual return of 12 percent.

This stock:

I.

is underpriced.

II. is overpriced.

III. will plot below the security market line.

IV. will plot above the security market line.

a. I and III only

b. I and IV only

c. II and III only

d. II and IV only

e. neither I, II, III, nor IV

REWARD-TO-RISK RATIO

c

50. If the market is efficient and securities are priced fairly then the _____ will be constant

for all securities.

a. systematic risk

b. standard deviation

c. reward-to-risk ratio

d. beta

e. risk premium

REWARD-TO-RISK RATIO

c

51. The reward-to-risk ratio for stock A exceeds the reward-to-risk ratio of stock B. Stock

A has a beta of 1.4 and stock B has a beta of .90. This information implies that:

a. stock A is riskier than stock B and both stocks are fairly priced.

b. stock A is less risky than stock B and both stocks are fairly priced.

c. either stock A is underpriced or stock B is overpriced or both.

d. both stock A and stock B are correctly priced since stock A is riskier than

stock B.

e. either stock A is overpriced or stock B is underpriced or both.

CHAPTER 13

MARKET RISK PREMIUM

d

52. The market risk premium is computed by:

a. adding the risk-free rate of return to the inflation rate.

b. adding the risk-free rate of return to the market rate of return.

c. subtracting the risk-free rate of return from the inflation rate.

d. subtracting the risk-free rate of return from the market rate of return.

e. multiplying the risk-free rate of return by a beta of 1.0.

MARKET RISK PREMIUM

b

53. The excess return earned by an asset that has a beta of 1.0 over that earned by a riskfree asset is referred to as the:

a. market rate of return.

b. market risk premium.

c. systematic return.

d. total return.

e. real rate of return.

MARKET RISK PREMIUM

d

54. The _____ divided by the beta of the market is equal to the slope of the Security

Market Line.

a. total return of the market

b. risk-free rate of return

c. real return of the market

d. market risk premium

e. nominal return of the market

CAPITAL ASSET PRICING MODEL (CAPM)

c

55. The Capital Asset Pricing Model (CAPM) assumes that:

I.

a risk-free asset has no systematic risk.

II. standard deviation measures systematic risk.

III. the risk-to-reward ratio is constant.

IV. a risk-free asset generally has a positive rate of return.

a. I and III only

b. II and IV only

c. I, III, and IV only

d. II, III, and IV only

e. I, II, and III only

CAPITAL ASSET PRICING MODEL (CAPM)

e

56. A security that has a rate of return that exceeds the U.S. Treasury bill rate but is less

than the market rate of return must:

a. be a risk-free asset.

b. have a beta that is greater than 1.0 but less than 2.0.

c. be a risk-free asset with a beta less than .99.

d. be a risky asset with a standard deviation less than 1.0.

e. be a risky asset with a beta less than 1.0.

CHAPTER 13

CAPITAL ASSET PRICING MODEL (CAPM)

b

57. Which of the following will increase the expected rate of return on an individual

security as computed by the Capital Asset Pricing Model (CAPM)? Assume that the

securitys beta, the risk-free rate of return, and the market rate of return are all

positive.

I.

a decrease in the securitys beta

II. an increase in the securitys beta

III. a decrease in the risk premium

IV. an increase in the market rate of return

a. I and III only

b. II and IV only

c. I and IV only

d. II and III only

e. II, III, and IV only

III. PROBLEMS

ANALYZING A PORTFOLIO

a

58. You want your portfolio beta to be 1.20. Currently, your portfolio consists of $100

invested in stock A with a beta of 1.4 and $300 in stock B with a beta of .6. You have

another $400 to invest and want to divide it between an asset with a beta of 1.6 and a

risk-free asset. How much should you invest in the risk-free asset?

a. $0

b. $140

c. $200

d. $320

e. $400

ANALYZING A PORTFOLIO

d

59. You have a $1,000 portfolio which is invested in stocks A and B plus a risk-free asset.

$400 is invested in stock A. Stock A has a beta of 1.3 and stock B has a beta of .7.

How much needs to be invested in stock B if you want a portfolio beta of .90?

a. $0

b. $268

c. $482

d. $543

e. $600

EXPECTED RETURN

c

60. You recently purchased a stock that is expected to earn 12 percent in a booming

economy, 8 percent in a normal economy and lose 5 percent in a recessionary

economy. There is a 15 percent probability of a boom, a 75 percent chance of a normal

economy, and a 10 percent chance of a recession. What is your expected rate of return

on this stock?

a. 5.00 percent

b. 6.45 percent

c. 7.30 percent

d. 7.65 percent

e. 8.30 percent

CHAPTER 13

EXPECTED RETURN

a

61. The Inferior Goods Co. stock is expected to earn 14 percent in a recession, 6 percent in

a normal economy, and lose 4 percent in a booming economy. The probability of a

boom is 20 percent while the probability of a normal economy is 55 percent and the

chance of a recession is 25 percent. What is the expected rate of return on this stock?

a. 6.00 percent

b. 6.72 percent

c. 6.80 percent

d. 7.60 percent

e. 11.33 percent

EXPECTED RETURN

b

62. You are comparing stock A to stock B. Given the following information, which one of

these two stocks should you prefer and why?

Rate of Return if

State of

Probability of

State Occurs

Economy

State of Economy

Stock A Stock B

Boom

60%

9%

15%

Recession

40%

4%

-6%

a. Stock A; because it has an expected return of 7 percent and appears to be more risky.

b. Stock A; because it has a higher expected return and appears to be less risky than stock

B.

c. Stock A; because it has a slightly lower expected return but appears to be significantly

less risky than stock B.

d. Stock B; because it has a higher expected return and appears to be just slightly more

risky than stock A.

e. Stock B; because it has a higher expected return and appears to be less risky than stock

A.

RISK PREMIUM

d

63. Zelo, Inc. stock has a beta of 1.23. The risk-free rate of return is 4.5 percent and the

market rate of return is 10 percent. What is the amount of the risk premium on Zelo

stock?

a. 4.47 percent

b. 5.50 percent

c. 5.54 percent

d. 6.77 percent

e. 12.30 percent

VARIANCE

c

64. If the economy booms, RTF, Inc. stock is expected to return 10 percent. If the

economy goes into a recessionary period, then RTF is expected to only return 4

percent. The probability of a boom is 60 percent while the probability of a recession is

40 percent. What is the variance of the returns on RTF, Inc. stock?

a. .000200

b. .000760

c. .000864

d. .001594

e. .029394

CHAPTER 13

VARIANCE

a

65. The rate of return on the common stock of Flowers by Flo is expected to be 14 percent

in a boom economy, 8 percent in a normal economy, and only 2 percent in a

recessionary economy. The probabilities of these economic states are 20 percent for a

boom, 70 percent for a normal economy, and 10 percent for a recession. What is the

variance of the returns on the common stock of Flowers by Flo?

a. .001044

b. .001280

c. .001863

d. .002001

e. .002471

STANDARD DEVIATION

c

66. Kurts Adventures, Inc. stock is quite cyclical. In a boom economy, the stock is

expected to return 30 percent in comparison to 12 percent in a normal economy and a

negative 20 percent in a recessionary period. The probability of a recession is 15

percent. There is a 30 percent chance of a boom economy. The remainder of the time

the economy will be at normal levels. What is the standard deviation of the returns on

Kurts Adventures, Inc. stock?

a. 10.05 percent

b. 12.60 percent

c. 15.83 percent

d. 17.46 percent

e. 25.04 percent

STANDARD DEVIATION

d

67. What is the standard deviation of the returns on a stock given the following

information?

State of

Economy

Boom

Normal

Recession

a.

b.

c.

d.

e.

Probability of

State of Economy

10%

60%

30%

Rate of Return

if State Occurs

16%

11%

-8%

5.80 percent

7.34 percent

8.38 percent

9.15 percent

9.87 percent

PORTFOLIO WEIGHT

d

68. You have a portfolio consisting solely of stock A and stock B. The portfolio has an

expected return of 10.2 percent. Stock A has an expected return of 12 percent while

stock B is expected to return 7 percent. What is the portfolio weight of stock A?

a. 46 percent

b. 54 percent

c. 58 percent

d. 64 percent

e. 70 percent

CHAPTER 13

PORTFOLIO WEIGHT

e

69. You own the following portfolio of stocks. What is the portfolio weight of stock C?

Number

Stock of Shares

A

100

B

600

C

400

D

200

a.

b.

c.

d.

e.

Price

per Share

$22

$17

$46

$38

30.8 percent

37.4 percent

42.3 percent

45.2 percent

47.9 percent

b

70. You own a portfolio with the following expected returns given the various states of the

economy. What is the overall portfolio expected return?

State of

Economy

Boom

Normal

Recession

a.

b.

c.

d.

e.

Probability of

State of Economy

15%

60%

25%

Rate of Return

if State Occurs

18%

11%

-10%

6.3 percent

6.8 percent

7.6 percent

10.0 percent

10.8 percent

b

71. What is the expected return on a portfolio which is invested 20 percent in stock A, 50

percent in stock B, and 30 percent in stock C?

State of

Economy

Boom

Normal

Recession

a.

b.

c.

d.

e.

7.40 percent

8.25 percent

8.33 percent

9.45 percent

9.50 percent

Probability of

State of Economy

20%

70%

10%

Stock A Stock B Stock C

18%

9%

6%

11%

7%

9%

-10%

4%

13%

CHAPTER 13

PORTFOLIO EXPECTED RETURN

d

72. What is the expected return on this portfolio?

Stock

A

B

C

a.

b.

c.

d.

e.

Expected

Return

8%

15%

6%

Number

of Shares

520

300

250

Stock

Price

$25

$48

$26

9.50 percent

9.67 percent

9.78 percent

10.59 percent

10.87 percent

c

73. What is the expected return on a portfolio comprised of $3,000 in stock K and $5,000

in stock L if the economy is normal?

State of

Economy

Boom

Normal

a.

b.

c.

d.

e.

Probability of

State of Economy

20%

80%

Stock K

Stock L

14%

10%

5%

6%

3.75 percent

5.25 percent

5.63 percent

5.88 percent

6.80 percent

d

74. What is the expected return on a portfolio comprised of $4,000 in stock M and $6,000

in stock N if the economy enjoys a boom period?

State of

Economy

Boom

Normal

Recession

a.

b.

c.

d.

e.

6.4 percent

6.8 percent

10.4 percent

13.2 percent

14.0 percent

Probability of

State of Economy

10%

75%

15%

Stock M

Stock N

18%

10%

7%

8%

-20%

6%

CHAPTER 13

PORTFOLIO VARIANCE

b

75. What is the portfolio variance if 30 percent is invested in stock S and 70 percent is

invested in stock T?

State of

Economy

Boom

Normal

a.

b.

c.

d.

e.

Probability of

State of Economy

40%

60%

Stock S

Stock T

12%

20%

6%

4%

.002220

.004056

.006224

.008080

.098000

PORTFOLIO VARIANCE

b

76. What is the variance of a portfolio consisting of $3,500 in stock G and $6,500 in stock

H.

State of

Economy

Boom

Normal

a.

b.

c.

d.

e.

Probability of

State of Economy

15%

85%

Stock G

Stock H

15%

9%

8%

6%

.000209

.000247

.002098

.037026

.073600

c

77. What is the standard deviation of a portfolio that is invested 40 percent in stock Q and

60 percent in stock R?

State of

Economy

Boom

Normal

a.

b.

c.

d.

e.

0.7 percent

1.4 percent

2.6 percent

6.8 percent

8.1 percent

Probability of

State of Economy

25%

75%

Stock Q

Stock R

18%

9%

9%

5%

CHAPTER 13

PORTFOLIO STANDARD DEVIATION

a

78. What is the standard deviation of a portfolio which is comprised of $4,500 invested in

stock S and $3,000 in stock T?

State of

Economy

Boom

Normal

Recession

a.

b.

c.

d.

e.

Probability of

State of Economy

10%

65%

25%

Stock S

Stock T

12%

4%

9%

6%

2%

9%

1.4 percent

1.9 percent

2.6 percent

5.7 percent

7.2 percent

d

79. What is the standard deviation of a portfolio which is invested 20 percent in stock A,

30 percent in stock B and 50 percent in stock C?

State of

Economy

Boom

Normal

Recession

a.

b.

c.

d.

e.

Probability of

State of Economy

10%

70%

20%

Stock A Stock B Stock C

15%

10%

5%

9%

6%

7%

-14%

2%

8%

0.6 percent

0.9 percent

1.8 percent

2.2 percent

4.9 percent

BETA

c

80. What is the beta of a portfolio comprised of the following securities?

Stock

A

B

C

a.

b.

c.

d.

e.

1.008

1.014

1.038

1.067

1.127

Amount

Invested

$2,000

$3,000

$5,000

Security

Beta

1.20

1.46

.72

CHAPTER 13

PORTFOLIO BETA

d

81. Your portfolio is comprised of 30 percent of stock X, 50 percent of stock Y, and 20

percent of stock Z. Stock X has a beta of .64, stock Y has a beta of 1.48, and stock Z

has a beta of 1.04. What is the beta of your portfolio?

a. 1.01

b. 1.05

c. 1.09

d. 1.14

e. 1.18

PORTFOLIO BETA

e

82. Your portfolio has a beta of 1.18. The portfolio consists of 15 percent U.S. Treasury

bills, 30 percent in stock A, and 55 percent in stock B. Stock A has a risk-level

equivalent to that of the overall market. What is the beta of stock B?

a. .55

b. 1.10

c. 1.24

d. 1.40

e. 1.60

PORTFOLIO BETA

b

83. You would like to combine a risky stock with a beta of 1.5 with U.S. Treasury bills in

such a way that the risk level of the portfolio is equivalent to the risk level of the

overall market. What percentage of the portfolio should be invested in Treasury bills?

a. .25

b. .33

c. .50

d. .67

e. .75

MARKET RISK PREMIUM

d

84. The market has an expected rate of return of 9.8 percent. The long-term government

bond is expected to yield 4.5 percent and the U.S. Treasury bill is expected to yield 3.4

percent. The inflation rate is 3.1 percent. What is the market risk premium?

a. 2.2 percent

b. 3.3 percent

c. 5.3 percent

d. 6.4 percent

e. 6.7 percent

CAPITAL ASSET PRICING MODEL (CAPM)

d

85. The risk-free rate of return is 4 percent and the market risk premium is 8 percent. What

is the expected rate of return on a stock with a beta of 1.28?

a. 9.12 percent

b. 10.24 percent

c. 13.12 percent

d. 14.24 percent

e. 15.36 percent

CHAPTER 13

CAPITAL ASSET PRICING MODEL (CAPM)

e

86. The common stock of Flavorful Teas has an expected return of 14.4 percent. The

return on the market is 10 percent and the risk-free rate of return is 3.5 percent. What

is the beta of this stock?

a. .65

b. 1.09

c. 1.32

d. 1.44

e. 1.68

CAPITAL ASSET PRICING MODEL (CAPM)

d

87. The stock of Big Joes has a beta a 1.14 and an expected return of 11.6 percent. The

risk-free rate of return is 4 percent. What is the expected return on the market?

a. 7.60 percent

b. 8.04 percent

c. 9.33 percent

d. 10.67 percent

e. 12.16 percent

CAPITAL ASSET PRICING MODEL (CAPM)

d

88. The expected return on HiLo stock is 13.69 percent while the expected return on the

market is 11.5 percent. The beta of HiLo is 1.3. What is the risk-free rate of return?

a. 2.8 percent

b. 3.1 percent

c. 3.7 percent

d. 4.2 percent

e. 4.5 percent

CAPITAL ASSET PRICING MODEL (CAPM)

c

89. The stock of Martin Industries has a beta of 1.43. The risk-free rate of return is 3.6

percent and the market risk premium is 9 percent. What is the expected rate of return

on Martin Industries stock?

a. 11.3 percent

b. 14.1 percent

c. 16.5 percent

d. 17.4 percent

e. 18.0 percent

CAPITAL ASSET PRICING MODEL (CAPM)

b

90. Nuvo, Inc. stock has a beta of .86 and an expected return of 10.5 percent. The risk-free

rate of return is 3.2 percent and the market rate of return is 11.2 percent. Which one of

the following statements is true given this information?

a. The return on Nuvo stock will graph below the Security Market Line.

b. Nuvo stock is underpriced.

c. The expected return on Nuvo stock based on the Capital Asset Pricing Model is 9.88

percent.

d. Nuvo stock has more systematic risk than the overall market.

e. Nuvo stock is correctly priced.

CHAPTER 13

REWARD-TO-RISK RATIO

b

91. Which one of the following stocks is correctly priced if the risk-free rate of return is

2.5 percent and the market risk premium is 8 percent?

Stock

A

B

C

D

E

a.

b.

c.

d.

e.

Beta

.68

1.42

1.23

1.31

.94

Expected Return

8.2%

13.9%

11.8%

12.6%

9.7%

A

B

C

D

E

c

92. Which one of the following stocks is correctly priced if the risk-free rate of return is

3.6 percent and the market rate of return is 10.5 percent?

Stock

A

B

C

D

E

a.

b.

c.

d.

e.

Beta

.85

1.08

1.69

.71

1.45

Expected Return

9.2%

11.8%

15.3%

7.8%

12.3%

A

B

C

D

E

IV. ESSAYS

CAPM

93. According to the CAPM, the expected return on a risky asset depends on three components.

Describe each component, and explain its role in determining expected return.

The CAPM suggests that the expected return is a function of (1) the risk-free rate of return,

which is the pure time value of money, (2) the market risk premium, which is the reward for

bearing systematic risk, and (3) beta, which is the amount of systematic risk present in a

particular asset. Better answers will point out that both the pure time value of money and the

reward for bearing systematic risk are exogenously determined and can change on a daily

basis, while the amount of systematic risk for a particular asset is determined by the firms

decision-makers.

CHAPTER 13

SECURITY MARKET LINE

94. Draw the SML and plot asset C such that it has less risk than the market but plots above the

SML, and asset D such that it has more risk than the market and plots below the SML. (Be

sure to indicate where the market portfolio is on your graph.) Explain how assets like C or D

can plot as they do and explain why such pricing cannot persist in a market that is in

equilibrium.

The student should correctly draw a SML with points C and D correctly identified. In this

case, asset C is underpriced and asset D is overpriced. This condition cannot persist in

equilibrium because investors will buy C with its high expected return and sell D with its

low expected return. This buying and selling activity will force the prices back to a level

that eventually causes both C and D to plot on the SML.

REWARD-TO-RISK RATIOS

95. Explain what we mean when we say all assets have the same reward-to-risk ratio. What does

this mean for investors?

A constant reward-to-risk ratio means that the reward for bearing risk (measured as the risk

premium) increases as the amount of risk (measured by beta) also increases. Investors who

are risk averse will not consider taking additional risk if they expect to receive no additional

compensation for doing so. This is an equilibrium concept which essentially restates the

axiom that prices observed in efficient markets are considered fair.

DIVERSIFIABLE RISK

96. Why are some risks diversifiable and some nondiversifiable? Give an example of each.

A reasonable answer would, at a minimum, explain that some risks (diversifiable) affect

only a specific security, and when put into a portfolio, losses as a result of these firmspecific events will tend to be offset by price gains amongst other securities.

Nondiversifiable risk, however, is unavoidable because such risks affect all or almost all

securities in the market and cant be eliminated by forming portfolios. In the second part of

the question, the students get a chance to use a minor amount of imagination. A strong

answer would note the dependence of diversification effects on the degree of correlation

between the assets used to form portfolios.

RISK

97. We routinely assume that investors are risk-averse return-seekers; i.e., they like returns and

dislike risk. If so, why do we contend that only systematic risk and not total risk is

important?

This question, of course, gets to the point of the chapter: That rational investors will

diversify away as much risk as possible. From the discussion in the text, most students will

also have picked up that it is quite easy to eliminate diversifiable risk in practice, either by

holding portfolios with 25 to 30 assets, or by holding shares in a diversified mutual fund.

And, as noted in the text, there will be no return for bearing diversifiable risk, thus, total

risk is not particularly important to a diversified investor.

CHAPTER 13

EMH, CAPM, AND THE MARKET VALUE RULE

98. In the first chapter, it was stated that financial managers should act to maximize shareholder

wealth. Why are the efficient markets hypothesis (EMH), the CAPM, and the SML so

important in the accomplishment of this objective?

In simple terms, one could say that maximizing shareholder wealth by maximizing the

current share price (Chapter 1) is a reasonable objective if and only if we have some

assurance that observed prices are meaningful; i.e., that they reflect the value of the firm.

This is a major implication of the EMH. Further, if we are to be able to assess the wealth

effects of future decisions on security and firm values, we must have a valuation model

whose parameters can be shown to be affected by those decisions (Chapters 7 and 8).

Finally, any valuation model we employ will require us to quantify return and risk (Chapters

12 and 13).

BETA

99. Explain in words what beta is and why it is important.

This is a concept check question that requires students to put into words that beta is a

measure of systematic risk, the only risk an investor can expect to earn compensation for

bearing. Beta specifically measures the amount of systematic risk an asset has relative to an

average asset.

NEGATIVE BETA

100. Is it possible for an asset to have a negative beta? (Hint: yes.) What would the expected

return on such an asset be? Why?

While it is unlikely to observe a negative beta asset, it would have less systematic risk than

the risk-free asset and would be expected to provide an even lower return. One possibility

often cited is that of gold. The return would be less than the risk-free rate because, while the

risk-free rate is determined by changes in inflation and the business cycle for the economy

at large, gold, as an ultimate store of value, is not affected by these factors (at least to the

same degree).

risk premium

the excess return required from an investment in a risky asset

over that required from a risk-free investment

variance

the average squared difference between the actual return and the

average return

standard deviation

the positive square root of the variance

normal distribution

a symmetric, bell-shaped frequency distribution that is

completely defined by its mean and standard deviation

geometric average return

the average compound return earned per year over a multiyear

period

arithmetic average return

the return earned in an average year over a multiyear period

efficient capital market

a market in which security prices reflect available information

efficient markets hypothesis (EMH)

the hypothesis that actual capital markets, such as the NYSE, are

efficient

volatility

standard deviation is a measure of

normal distribution

defined by its mean and its standard deviation

geometric

the average compound return earned per year over a multi-year

period is the - average return

arithmetic

the return earned in an average year over a multi-year period is

called the - average return

efficient capital market

assume that the market prices of the securities that trade in a

particular market fairly reflect the available information related

to those securities. which one of the following terms best defines

that market?

risk less market

evenly distributed market

zero volatility market

blumes market

efficient capital market

Efficient market hypothesis

all securities in this market are zero at nvp investments

dividend yield

next years annual dividend divided by todays stock price

capital gains

an increase in an unrealized capital gain will increase the capital

gains yield

I & III

correct in relation to a sock investment

I capital gains yield can be positive, negative, or zero

II dividend yield can be positive, negative, or zero

III total return can be positive, negative, or zero

IV neither the dividend yield nor the total return can be negative

minus the inflation rate

nominal rate of return:

less than

as long as the inflation rate is positive, the real rate of return on a

security will be - the nominal rate of return

greater than

equal to

less than

greater than or equal to

unrelated to

c

small-co stocks are best defined as

a 500 newest corporations in the US

b firms whose stock trades otc

c smallest 20% of the firms listed on the NYSE

d smallest 20% of the firms listed on the NASDAQ

e firms whose stock is listed on NASDAQ

small company stocks

which category of securities had the highest average return for

1926-2007

US t bills

had the lowest average risk premium in 26-07

small company stocks

most volatile returns over 26-07

us t bills

- - - had a positive average real rate of return in 1926-2007

c

which time periods are associated with high rates of inflation

a 1929-1933

b 1957-1961

c 1978-1981

d 1992-1996

e 2001-2005

positive

10-15%

highest annual rate of inflation in 1926-2007

between 0-3%

3-5%

5-10%

10-15%

15-20%

excess return

this is computed as return on a risky security minus the risk free

rate

small company stocks

earned the highest risk premium 1926-2007

3.0-3.5

average rate of inflation between 1926-2007

< 2%

2.0-2.5

2.5-3.0

3.0-3.5

> 3.5%

10-12.5%

assume that you invest in a porfolio of large company stocks.

further assume that the portfolio will earn a rate of return similar

to the average return on large-company stocks for 1926-2007.

what rate of return should you expect to earn?

< 10%

10-12.5%

12.5%-15%

15-17.5%

>17.5%

5

the average annual return on small-company stocks was about % greater than the average annual return on large-company

stocks 0ver 1926-2007

US t bills

lease volatile from 1926-2007

the greater the volatility of returns,

III & IV

correspond to a wide frequency distribution

I relatively low risk

II low rate of return

III relatively high standard deviation

IV relatively large risk premium

increase the risk premium

to convince investors to accept greater volatility you must,

II & III

if the variability of the returns on large compnay stocks were to

increase over the long-term, you would expect which of the

following to occur as a result?

I dec in the average rate of return

II increase in the risk premium

III increase in the 68% probability range of the frequency

distribution of returns

IV dec in the standard deviation

lower return, long term

long term government bonds had a - - but a higher standard

deviation on average than did - corporate bonds

16%

probability that small-company stocks wil produce an annual

return that is more then one standard deviation below the

average

1%

2.5%

5.0%

16%

32%

6.8%

according to jeremy siegel, the real return on stocks over the

long-term has averaged about:

6.8%

8.7%

10.4%

12.3%

14.8%

IV

which is true based on the historical record for 1926-2007

I risk and potential reward are inversely related

II risk free securities produce a positive real rate of return each

year

III returns are more predictable over the short-term than they

are over the long-term

IV bonds are generally a safer investment than are stocks

overestimate, underestimate

estimates of the rate of return on a security based on a historical

artihmetic average will probably tend to - the expexted return for

the long-term while estimates using the historical geometric

average will probably tend to - the expected return for the short

term

project future rates of return

the primary purpose of blumes formula is to

III & IV

which two of the following are the most likely reasons why a stock

price might not react at all on the day that new information

related to the stock issuer is released?

I insiders know the info prior to the announcement

II investors need time to digest the information prior to reacting

III the information has no bearing on the value of the firm

IV the information was anticipated

weak

if you excel in analyzing the future outlook of firms, you would

prefer the financial market be- form efficient so that you can have

an advantage in the marketplace

semistrong

you are aware that your neighbor trades stocks based on

confidential info he overhears at his workplace. this information

is not available to the general public. this neighbor continually

brags to you about the profits he earns on these trades. given this

you would tent to argue that the financial markets are at best from efficient

weak

semiweak

semistrong

strong perfect

stong

th us securities and exchange commission periodically charges

infividuals with insider trading and claims those individuals have

made unfair profits. given this you would be most apt to argure

that the markets are less than - form efficient

weak

semiweak

semistrong

strong

perfect

-3.96

one year ago, you purchase a stock at price of $32.16. the stock

pays quarterly dividends of $.20 per share. today, the stock is

selling for $28.20 per share. what is your capital gain on this

investment?

-4.16

-3.96

-3.76

-3.16

-2.96

percent in a good

economy and 3 percent in a poor economy. Given the

probabilities of each state of the economy occurring, you

anticipate that your stock will earn 6.5 percent next year. Which

one of the following terms applies to this 6.5 percent?

a. arithmetic return

b. historical return

c. expected return

d. geometric return

e. required return

c. expected return

Suzie owns five different bonds valued at $36,000 and twelve

different stocks

valued at $82,500 total. Which one of the following terms most

applies to Suzie's

investments?

a. index

b. portfolio

c. collection

d. grouping

e. risk-free

b. portfolio

Steve has invested in twelve different stocks that have a

combined value today of

$121,300. Fifteen percent of that total is invested in Wise Man

Foods. The 15 percent is a

measure of which one of the following?

a. portfolio return

b. portfolio weight

c. degree of risk

d. price-earnings ratio

e. index value

b. portfolio weight

Which one of the following is a risk that applies to most

securities?

a. unsystematic

b. diversifiable

c. systematic

d. asset-specific

e. total

c. systematic

suddenly drop in

value by about 20 percent. What type of risk does this news

flash represent?

a. portfolio

b. nondiversifiable

c. market

d. unsystematic

e. total

d. unsystematic

The principle of diversification tells us that:

a. concentrating an investment in two or three large stocks will

eliminate all of the unsystematic risk.

b. concentrating an investment in three companies all within

the same industry will greatly reduce the systematic risk.

c. spreading an investment across five diverse companies will

not lower the total risk.

d. spreading an investment across many diverse assets will

eliminate all of

the systematic risk.

e. spreading an investment across many diverse assets will

eliminate some of the total risk.

e. spreading an investment across many diverse assets will

eliminate

some of the total risk.

The _____ tells us that the expected return on a risky asset

depends only on that

asset's nondiversifiable risk. a. efficient markets hypothesis

b. systematic risk principle

c. open markets theorem

d. law of one price

e. principle of diversification

b. systematic risk principle

Which one of the following measures the amount of systematic

risk present in a

particular risky asset relative to the systematic risk present in

an average risky asset?

a. beta

b. reward-to-risk ratio

c. risk ratio

d. standard deviation

e. price-earnings ratio

a. beta

that is created

when expected returns are graphed against security betas?

a. reward-to-risk matrix

b. portfolio weight graph

c. normal distribution

d. security market line

e. market real returns

d. security market line

Which one of the following is represented by the slope of the

security market line?

a. reward-to-risk ratio

b. market standard deviation

c. beta coefficient

d. risk-free interest rate

e. market risk premium

e. market risk premium

Which one of the following is the formula that explains the

relationship between

the expected return on a security and the level of that security's

systematic risk?

a. capital asset pricing model

b. time value of money equation

c. unsystematic risk equation

d.market performance equation

e. expected risk formula

a. capital asset pricing model

Treynor Industries is investing in a new project. The minimum

rate of return the

firm requires on this project is referred to as the:

a. average arithmetic return.

b. expected return.

c. market rate of return.

d. internal rate of return.

e. cost of capital.

e. cost of capital

The expected return on a stock given various states of the

economy is equal to the:

a. highest expected return given any economic state.

b. arithmetic average of the returns for each economic state.

d. weighted average of the returns for each economic state.

e. return for the economic state with the highest probability of

occurrence.

d. weighted average of the returns for each economic state.

The expected return on a stock computed using economic

probabilities is:

a. guaranteed to equal the actual average return on the stock for

the next five years.

b. guaranteed to be the minimal rate of return on the stock over

the next two years.

c. guaranteed to equal the actual return for the immediate

twelve month period.

d. a mathematical expectation based on a weighted average and

not an actual anticipated outcome.

e. the actual return you should anticipate as long as the

economic forecast remains constant.

d. a mathematical expectation based on a weighted average and

not an

actual anticipated outcome

The expected risk premium on a stock is equal to the expected

return on the stock

minus the:

a. expected market rate of return.

b. risk-free rate.

c. inflation rate.

d. standard deviation.

e. variance.

b. risk-free rate

Standard deviation measures which type of risk?

a. total

b. nondiversifiable

c. unsystematic

d. systematic

e. economic

a. total

The expected rate of return on a stock portfolio is a weighted

average where the

weights are based on the:

a. number of shares owned of each stock.

b.market price per share of each stock.

c. market value of the investment in each stock.

e. cost per share of each stock held.

c. market value of the investment in each stock.

The expected return on a portfolio considers which of the

following factors?

I. percentage of the portfolio invested in each individual

security

II. projected states of the economy

III. the performance of each security given various economic

states

IV. probability of occurrence for each state of the economy

ALL

I. can never exceed the expected return of the best performing

security in the portfolio.

II. must be equal to or greater than the expected return of the

worst performing security in the

portfolio.

III. is independent of the unsystematic risks of the individual

securities held in the portfolio.

IV. is independent of the allocation of the portfolio amongst

individual securities.

I, II and III only

If a stock portfolio is well diversified, then the portfolio

variance:

a. will equal the variance of the most volatile stock in the

portfolio.

b. may be less than the variance of the least risky stock in the

portfolio.

c. must be equal to or greater than the variance of the least risky

stock in the portfolio.

d. will be a weighted average of the variances of the individual

securities in the portfolio.

e. will be an arithmetic average of the variances of the

individual

securities in the portfolio.

b. may be less than the variance of the least risky stock in the

portfolio.

The standard deviation of a portfolio:

a. is a weighted average of the standard deviations of the

individual securities held in the portfolio.

b. can never be less than the standard deviation of the most

risky security in the portfolio.

deviation of any single security held in the portfolio.

d. is an arithmetic average of the standard deviations of the

individual securities which comprise the portfolio.

e. can be less than the standard deviation of the least risky

security in the portfolio.

e. can be less than the standard deviation of the least risky

security in the portfolio.

The standard deviation of a portfolio:

a. is a measure of that portfolio's systematic risk.

b. is a weighed average of the standard deviations of the

individual securities held in that portfolio.

c. measures the amount of diversifiable risk inherent in the

portfolio.

d. serves as the basis for computing the appropriate risk

premium for that portfolio.

e. can be less than the weighted average of the standard

deviations of the individual securities held in that portfolio.

e. can be less than the weighted average of the standard

deviations of the individual securities held in that portfolio.

Which one of the following statements is correct concerning a

portfolio of 20 securities with multiple states of the economy

when both the securities and the economic states have unequal

weights?

a. Given the unequal weights of both the securities and the

economic states, the standard deviation of the portfolio must

equal that of the overall

market.

b. The weights of the individual securities have no effect on the

expected return of a portfolio when multiple states of the

economy are involved.

c. Changing the probabilities of occurrence for the various

economic states will not affect the expected standard deviation

of the portfolio.

d. The standard deviation of the portfolio will be greater than

the highest

standard deviation of any single security in the portfolio given

that the

individual securities are well diversified.

e. Given both the unequal weights of the securities and the

economic states,

an investor might be able to create a portfolio that has an

expected standard deviation of zero.

economic states,

an investor might be able to create a portfolio that has an

expected standard deviation of zero.

Which one of the following events would be included in the

expected return on

Sussex stock?

a. The chief financial officer of Sussex unexpectedly resigned.

b. The labor union representing Sussex' employees

unexpectedly called a strike.

c. This morning, Sussex confirmed that its CEO is retiring at the

end of the year as was anticipated.

d. The price of Sussex stock suddenly declined in value because

researchers accidentally discovered that one of the firm's

products can be toxic to household pets.

e. The board of directors made an unprecedented decision to

give sizeable bonuses to the firm's internal auditors for their

efforts in uncovering wasteful spending.

c. This morning, Sussex confirmed that its CEO is retiring at the

end of the

year as was anticipated.

Which one of the following statements is correct?

a. The unexpected return is always negative.

b. The expected return minus the unexpected return is equal to

the total return.

c. Over time, the average return is equal to the unexpected

return.

d. The expected return includes the surprise portion of news

announcements.

e. Over time, the average unexpected return will be zero.

e. Over time, the average unexpected return will be zero.

Which one of the following statements related to unexpected

returns is correct?

a. All announcements by a firm affect that firm's unexpected

returns.

b. Unexpected returns over time have a negative effect on the

total return of a firm.

c. Unexpected returns are relatively predictable in the shortterm.

d. Unexpected returns generally cause the actual return to vary

significantly from the expected return over the long-term.

e. Unexpected returns can be either positive or negative in the

short term but tend to be zero over the long-term.

short term

but tend to be zero over the long-term.

Which one of the following is an example of systematic risk?

a. investors panic causing security prices around the globe to

fall precipitously

b. a flood washes away a firm's warehouse

c. a city imposes an additional one percent sales tax on all

products

d. a toymaker has to recall its top-selling toy

e. corn prices increase due to increased demand for alternative

fuels

a. investors panic causing security prices around the globe to fall

precipitously

Unsystematic risk:

a. can be effectively eliminated by portfolio diversification.

b. is compensated for by the risk premium.

c. is measured by beta.

d. is measured by standard deviation.

e. is related to the overall economy.

a. can be effectively eliminated by portfolio diversification.

Which one of the following is an example of unsystematic risk?

a. income taxes are increased across the board

b. a national sales tax is adopted

c. inflation decreases at the national level

d. an increased feeling of prosperity is felt around the globe

e. consumer spending on entertainment decreased nationally

e. consumer spending on entertainment decreased nationally

Which one of the following is least apt to reduce the

unsystematic risk of a

portfolio?

a. reducing the number of stocks held in the portfolio

b. adding bonds to a stock portfolio

c. adding international securities into a portfolio of U.S. stocks

d. adding U.S. Treasury bills to a risky portfolio

e. adding technology stocks to a portfolio of industrial stocks

a. reducing the number of stocks held in the portfolio

Which one of the following statements is correct concerning

unsystematic risk?

a. An investor is rewarded for assuming unsystematic risk.

individual investor.

c. Unsystematic risk is rewarded when it exceeds the market

level of unsystematic risk.

d. Beta measures the level of unsystematic risk inherent in an

individual security.

e. Standard deviation is a measure of unsystematic risk.

b. Eliminating unsystematic risk is the responsibility of the

individual investor.

Which one of the following statements related to risk is correct?

a. The beta of a portfolio must increase when a stock with a high

standard deviation is added to the portfolio.

b. Every portfolio that contains 25 or more securities is free of

unsystematic risk.

c. The systematic risk of a portfolio can be effectively lowered by

adding T-bills to the portfolio.

d. Adding five additional stocks to a diversified portfolio will

lower the portfolio's beta.

e. Stocks that move in tandem with the overall market have zero

betas.

c. The systematic risk of a portfolio can be effectively lowered by

adding

T-bills to the portfolio.

Which one of the following risks is irrelevant to a welldiversified investor?

a. systematic risk

b. unsystematic risk

c. market risk

d.nondiversifiable risk

e. systematic portion of a surprise

b. unsystematic risk

Which of the following are examples of diversifiable risk?

I. earthquake damages an entire town

II. federal government imposes a $100 fee on all business

entities

III. employment taxes increase nationally

IV. toymakers are required to improve their safety standards

I and IV only

Which of the following statements are correct concerning

diversifiable risks?

I. Diversifiable risks can be essentially eliminated by investing

in thirty unrelated securities.

III. Diversifiable risks are generally associated with an

individual firm or industry.

IV. Beta measures diversifiable risk.

I, II, and III

Which one of the following is the best example of a diversifiable

risk?

a. interest rates increase

b. energy costs increase

c. core inflation increases

d. a firm's sales decrease

e. taxes decrease

d. a firm's sales decrease

Which of the following statements concerning risk are correct?

I. Nondiversifiable risk is measured by beta.

II. The risk premium increases as diversifiable risk increases.

III. Systematic risk is another name for nondiversifiable risk.

IV. Diversifiable risks are market risks you cannot avoid.

I and III

The primary purpose of portfolio diversification is to:

a. increase returns and risks.

b. eliminate all risks.

c. eliminate asset-specific risk.

d. eliminate systematic risk.

e. lower both returns and risks.

c. eliminate asset-specific risk.

Which one of the following indicates a portfolio is being

effectively diversified?

a. an increase in the portfolio beta

b. a decrease in the portfolio beta

c. an increase in the portfolio rate of return

d. an increase in the portfolio standard deviation

e. a decrease in the portfolio standard deviation

e. a decrease in the portfolio standard deviation

How many diverse securities are required to eliminate the

majority of the

diversifiable risk from a portfolio?

5

10

25

50

75

25

Systematic risk is measured by:

a. the mean.

b. beta.

c. the geometric average.

d. the standard deviation.

e. the arithmetic average.

b. beta

Which one of the following is most directly affected by the level

of systematic risk

in a security?

a. variance of the returns

b. standard deviation of the returns

c. expected rate of return

d. risk-free rate

e. market risk premium

c. expected rate of return

Which one of the following statements is correct concerning a

portfolio beta?

a. Portfolio betas range between -1.0 and +1.0.

b. A portfolio beta is a weighted average of the betas of the

individual securities contained in the portfolio.

c. A portfolio beta cannot be computed from the betas of the

individual securities comprising the portfolio because some risk

is eliminated via diversification.

d. A portfolio of U.S. Treasury bills will have a beta of +1.0.

e. The beta of a market portfolio is equal to zero.

b. A portfolio beta is a weighted average of the betas of the

individual

securities contained in the portfolio.

The systematic risk of the market is measured by:

a. a beta of 1.0.

b. a beta of 0.0.

c. a standard deviation of 1.0.

d. a standard deviation of 0.0.

e. a variance of 1.0.

a. a beta of 1.0

to estimate the

amount of additional reward you will receive for purchasing a

risky asset instead of a risk-free

asset?

I. asset's standard deviation

II. asset's beta

III. risk-free rate of return

IV. market risk premium

II and IV only

Total risk is measured by _____ and systematic risk is

measured by _____.

a. beta; alpha

b. beta; standard deviation

c. alpha; beta

d. standard deviation; beta

e. standard deviation; variance

d. standard deviation; beta

The intercept point of the security market line is the rate of

return which

corresponds to:

a. the risk-free rate.

b. the market rate.

c. a return of zero.

d. a return of 1.0 percent.

e. the market risk premium.

a. the risk free rate

A stock with an actual return that lies above the security market

line has:

a. more systematic risk than the overall market.

b. more risk than that warranted by CAPM.

a higher return than expected for the level of risk assumed.

less systematic risk than the overall market.

a return equivalent to the level of risk assumed.

c. a higher return than expected for the level of risk assumed.

The market rate of return is 11 percent and the risk-free rate of

return is 3 percent.

Lexant stock has 3 percent less systematic risk than the market

and has an actual return of

12 percent. This stock:

a. is underpriced.

b.is correctly priced.

d. will plot on the security market line.

e. will plot to the right of the overall market on a security

market line graph.

a. is underpriced

Which one of the following will be constant for all securities if

the market is efficient

and securities are priced fairly?

a. variance

b. standard deviation

c. reward-to-risk ratio

d. beta

e. risk premium

c. reward-to-risk ratio

The market risk premium is computed by:

a. adding the risk-free rate of return to the inflation rate.

b. adding the risk-free rate of return to the market rate of

return.

c. subtracting the risk-free rate of return from the inflation rate.

d. subtracting the risk-free rate of return from the market rate

of return.

e. multiplying the risk-free rate of return by a beta of 1.0.

d. subtracting the risk-free rate of return from the market rate of

return.

The excess return earned by an asset that has a beta of 1.34 over

that earned by

a risk-free asset is referred to as the:

a. market risk premium.

b. risk premium.

c. systematic return.

d. total return.

e. real rate of return.

b. risk premium

The _____ of a security divided by the beta of that security is

equal to the slope of

the security market line if the security is priced fairly.

a. real return

b. actual return

c. nominal return

d. risk premium

e. expected return

d. risk premium

following?

I. a risk-free asset has no systematic risk.

II. beta is a reliable estimate of total risk.

III. the reward-to-risk ratio is constant.

IV. the market rate of return can be approximated.

I, III, IV

According to CAPM, the amount of reward an investor receives

for bearing the risk

of an individual security depends upon the:

a. amount of total risk assumed and the market risk premium.

b. market risk premium and the amount of systematic risk

inherent in the security.

c. risk free rate, the market rate of return, and the standard

deviation of the security.

d. beta of the security and the market rate of return.

e. standard deviation of the security and the risk-free rate of

return.

b. market risk premium and the amount of systematic risk

inherent in

the security.

Which one of the following should earn the most risk premium

based on CAPM?

a. diversified portfolio with returns similar to the overall market

b. stock with a beta of 1.38

c. stock with a beta of 0.74

d. U.S. Treasury bill

e. portfolio with a beta of 1.01

b. stock with a beta of 1.38

Please allow access to your computers microphone to use Voice Recording.

Having trouble? Click here for help.

- Introduction to Ratio Analysis FinalDiunggah olehmd abdul khalek
- Paper FinanceeeeeeeeeeDiunggah olehrt
- 10 nomor ekotekDiunggah olehNurman Wibisana
- Chapter III Research MethodologyDiunggah olehRageeth Padman R A
- CONTRACT & PROCUREMENT MANAGEMENT REPORT NTPCDiunggah olehSiddharth
- Chap 007Diunggah olehsueern
- Analysis of Mean & Std DevDiunggah olehsunithanitw
- Chap 016Diunggah olehrayjoshua12
- A Comparative Analysis of Residential and Retail CommercialDiunggah olehAlexander Decker
- Ratio Analysis of Ncl by Shrawan Kumar DwivediDiunggah olehShrawan Dwivedi
- Chord Technologies Ltd. October_2001_Solution Exam CMADiunggah olehcrystal1224
- Rozar FinanceDiunggah olehRozar Parmar
- Oyelere ArticleDiunggah olehagata1520
- Komal FinalDiunggah olehsauravv7
- Level 1 ACC RatiosDiunggah olehSebastian Martin Vicente
- Managerial AccountingDiunggah olehManna Mahadi
- 88Diunggah olehaprilia wahyu perdani
- CEF Module 1.04 Basics of FinanceDiunggah olehArvind
- Chapter_4 Time Value of Money Part 1Diunggah olehMahmuddin Amin
- John.docxDiunggah olehLucky Lucky
- Department of Labor: peerreviewresponse092506Diunggah olehDepartment of Labor
- Ba9222 Fm QbDiunggah olehAnonymous uHT7dD
- Presentation1.pptxDiunggah olehunsaarshad
- PPTTNNDiunggah olehVibhorBajpai
- RealEstate Analysis Form SampleDiunggah olehHesbon Moriasi
- Investment managementDiunggah olehMir Hassan
- analysis of pakistan petroleum limitedDiunggah olehMBA...KID
- MJJ2Diunggah olehapi-3811122
- statpaper(1).docxDiunggah oleharavindreddy
- SAPM.pptxDiunggah olehpratima

- Finance first part Quiz - Chapter fourDiunggah olehBasa Tany
- FINA 4001 Ch 13Diunggah olehJesus Colin Campuzano
- Practice Questions Final Exam-financial managementDiunggah olehNilotpal Chakma
- MGT 3062 Test 4Diunggah olehJesus Colin Campuzano
- 1Diunggah olehJesus Colin Campuzano
- Sample Questions 5-6Diunggah olehjangrapa
- fdgfdsgdfgDiunggah olehJesus Colin Campuzano
- dfgdfgfDiunggah olehJesus Colin Campuzano
- Chap 006Diunggah olehkwathom1
- Chapter 7Diunggah olehMorerp
- 2006 Test 2Diunggah olehJesus Colin Campuzano
- 2006 Test 1Diunggah olehJesus Colin Campuzano
- Poisson RationDiunggah olehJesus Colin Campuzano
- 01 CoverDiunggah olehJesus Colin Campuzano
- Transportation Test 1 Scan 005Diunggah olehJesus Colin Campuzano
- CH 10 testDiunggah olehJesus Colin Campuzano
- ch01.pdfDiunggah olehssrames7282
- Test01.pdfDiunggah olehJesus Colin Campuzano
- Dynamcs FinalDiunggah olehJesus Colin Campuzano

- Edu Toy Descriptive AnalyticsDiunggah olehKiran Mishra
- 360 Autumn 2006 Virtual LeadershipDiunggah olehsmchou
- 7110_s10_qp_21Diunggah olehMERCY LAW
- W12 OMS311 SyllabusDiunggah olehYoung H. Cho
- Accounting 2 -Student handout -Chapter questions (6).xlsxDiunggah olehKeri Kohler
- Reengineer or PerishDiunggah olehGie Serrano-Dumpit
- Lecture 5 - Account Receivables and Inventory ManagementDiunggah olehMaaz
- Logistics TopicsDiunggah olehashish.bms9
- Classified_2015_04_29_000000Diunggah olehsasikala
- JennPhommachak_resumeREVISEDDiunggah olehj_phommachak
- Chap008.docDiunggah olehdbjn
- Solution Correction for Suggested Problems ExercisesDiunggah olehJoy T
- Cost SheetDiunggah olehAnkit Yadav
- Zara Case StudyDiunggah olehSaatvik Sethi
- Volume 2 India Ver 141005.pdfDiunggah olehTy Hh
- PeopleSoft Enterprise Inventory 9.1Diunggah olehAli Imran
- Dell Computer CorporationDiunggah olehkartiki_thorave6616
- Paper-8Diunggah olehkrittika19
- SM MCQDiunggah olehhello1267
- OPERATION RESEARCH 2 mark questions with answers.docxDiunggah olehM.Thirunavukkarasu
- Wil36679 Appb b1 b12 Accounting PrinicDiunggah olehThalia Sanders
- SMED Case Study.pdfDiunggah olehBagus Dhaka
- Lean Management - An Introduction - SlidesDiunggah olehanon_258949213
- Test Bank - Chapter 4 Process Costing.docDiunggah olehmaisie lane
- financial-ratio-cheatsheet.pdfDiunggah olehJanlenn Gepaya
- dba's take on mscaDiunggah olehpattong999
- mm T codesDiunggah olehThirtha Prasad
- Berkeley Casebook 2006 for Case Interview Practice | MasterTheCaseDiunggah olehMasterTheCase.com
- Inventory Management - 2015 - TLG.pptDiunggah olehdillysri
- List QuestionsDiunggah olehMohamed Abdulrahman

## Lebih dari sekadar dokumen.

Temukan segala yang ditawarkan Scribd, termasuk buku dan buku audio dari penerbit-penerbit terkemuka.

Batalkan kapan saja.