Corporate Finance - Quiz 02

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

a. arithmetic

A stock has an expected return of 11 percent, the risk-free rate is 5.2 percent, and the market risk premium is 5 percent. What is the stock's beta? a. 1.08 b. 1.16 c. 1.29 d. 1.32 e. 1.35

b. 1.16

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

Efficient financial markets fluctuate continuously because: a. the markets are continually reacting to old information as that information is absorbed. b. the markets are continually reacting to new information. c. arbitrage trading is limited. d. current trading systems require human intervention. e. investments produce varying levels of net present values.

b. the markets are continually reacting to new information.

What is the probability that small-company stocks will produce an annual return that is more than one standard deviation below the average? a. 1.0 percent b. 2.5 percent c. 5.0 percent d. 16 percent e. 32 percent

d. 16 percent

You find a certain stock that had returns of 4 percent, -5 percent, -15 percent, and 16 percent for four of the last five years. The average return of the stock for the past year-year period was 8 percent. What is the standard deviation of the stock's returns for the 5-year period? a. 21.39 percent b. 24.98 percent c. 27.16 percent d. 21.22 percent e. 34.02 percent

d. 21.22 percent

Which one of the following statements best defines the efficient market hypothesis? a. Efficient markets limit competition. b. Security prices in efficient markets remain steady as new information becomes available. c. Mispriced securities are common in efficient markets. d. All securities in an efficient market are zero net present value investments. e. Profits are removed as a market incentive when markets become efficient.

d. All securities in an efficient market are zero net present value investments.

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

Suppose you observe the following situation: State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Bust 0.22 -0.12 -0.27 Normal 0.48 0.10 0.05 Boom 0.30 0.23 0.28 Assume the capital asset pricing model holds and stock A's beta is greater than stock B's beta by 0.21. What is the expected market risk premium? a. 8.8 percent b. 9.5 percent c. 12.6 percent d. 17.9 percent e. 20.0 percent

e. 20.0 percent

Consider the following information on stocks I and II: State of Economy Probability of State of Economy Rate of Return if State Occurs Stock I Stock II Recession 0.06 0.15 -0.35 Normal 0.69 0.35 0.35 Irrational exuberance 0.25 0.43 0.45 The market risk premium is 8 percent, and the risk-free rate is 3.6 percent. The beta of stock I is _____ and the beta of stock II is _____. a. 2.08; 2.47 b. 2.08; 2.76 c. 3.21; 3.84 d. 4.47; 3.89 e. 4.03; 3.71

e. 4.03; 3.71

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 categories of securities has had the most volatile returns over the period 1926-2010? a. long-term corporate bonds b. large-company stocks c. intermediate-term government bonds d. U.S. Treasury bills e. small-company stocks

e. small-company stocks

Which one of the following statements is correct? 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 return, the greater the risk premium. d. The risk premium is unrelated to the average rate of return. e. The risk premium is not affected by the volatility of returns.

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

You bought one of Shark Repellant's 8 percent coupon bonds one year ago for $802. These bonds pay annual payments, have a face value of $1,000, and mature 14 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 12 percent. The inflation rate over the past year was 3.7 percent. What was your total real return on this investment? a. 2.97 percent b. -2.02 percent c. -1.18 percent d. 3.44 percent e. 2.58 percent

b. -2.02 percent

A stock has an expected rate of return of 13 percent and a standard deviation of 21 percent. Which one of the following best describes the probability that this stock will lose at least half of its value in any one given year? a. 1 percent b. .5 percent c. 1.0 percent d. 2.5 percent e. v5.0 percent

b. .5 percent

Individuals who continually monitor the financial markets seeking mispriced securities: a. earn excess profits over the long-term. b. make the markets increasingly more efficient. c. are never able to find a security that is temporarily mispriced. d. are overwhelmingly successful in earning abnormal profits. e. are always quite successful using only historical price information as their basis of evaluation.

b. make the markets increasingly more efficient.

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.

Standard deviation is a measure of which one of the following? a. average rate of return b. volatility c. probability d. risk premium e. real returns

b. volatility

A stock had annual returns of 16 percent, 8 percent, -17 percent, and 21 percent for the past four years. Based on this information, what is the 95 percent probability range of returns for any one given year? a. -9.87 to 23.87 percent b. -24.60 to 31.80 percent c. -26.74 to 40.74percent d. -47.68 to 54.68 percent e. -50.54 to 57.61 percent

c. -26.74 to 40.74percent

If the variability of the returns on large-company stocks were to decrease over the long-term, you would expect which one of the following to occur as a result? a. Increase in the risk premium b. Increase in the average long-term rate of return c. Decrease in the 68 percent probability range of returns d. Increase in the standard deviation e. Increase in the geometric average rate of return

c. Decrease in the 68 percent probability range of returns

Which of the following statements is correct in relation to a stock investment? I. The capital gains yield can be positive, negative, or zero. II. The dividend yield can be positive, negative, or zero. III. The total return can be positive, negative, or zero. IV. Neither the dividend yield nor the total return can be negative. a. I only b. I and II only c. I and III only d. I and IV only e. IV only

c. I and III only

If the variability of the returns on large-company stocks were to increase over the long-term, you would expect which of the following to occur as a result? I. decrease in the average rate of return II. increase in the risk premium III. increase in the 68 percent probability range of the frequency distribution of returns IV. decrease in the standard deviation a. I only b. IV only c. II and III only d. I and III only e. II and IV only

c. II and III only

Which one of the following statements is correct based on the historical record for the period 1926-2010? a. The standard deviation of returns for small-company stocks was double that of large-company stocks. b. U.S. Treasury bills had a zero standard deviation of returns because they are considered to be risk-free. c. Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds. d. Inflation was less volatile than the returns on U.S. Treasury bills. e. Long-term government bonds underperformed intermediate-term government bonds.

c. Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds.

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.

Bayside Marina just announced it is decreasing its annual dividend from $1.64 per share to $1.50 per share effective immediately. If the dividend yield remains at its pre-announcement level, then you know the stock price: a. was unaffected by the announcement. b. increased proportionately with the dividend decrease. c. decreased proportionately with the dividend decrease. d. decreased by $0.14 per share. e. increased by $0.14 per share.

c. decreased proportionately with the dividend decrease.

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

c. 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. a. greater than b. equal to c. less than d. greater than or equal to e. unrelated to

c. less than

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).

c. minus the inflation rate.

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

You are aware that your neighbor trades stocks based on confidential information 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 tend to argue that the financial markets are at best _____ form efficient. a. weak b. semiweak c. semistrong d. strong e. perfect

c. semistrong

Which one of the following categories of securities had the highest average return for the period 1926-2010? a. U.S. Treasury bills b. large company stocks c. small company stocks d. long-term corporate bonds e. long-term government bonds

c. small company stocks

Small-company stocks, as the term is used in the textbook, are best defined as the: a. 500 newest corporations in the U.S. b. firms whose stock trades OTC. c. smallest twenty percent of the firms listed on the NYSE. d. smallest twenty-five percent of the firms listed on NASDAQ. e. firms whose stock is listed on NASDAQ.

c. smallest twenty percent of the firms listed on the NYSE.

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. 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. Either stock A is overpriced or stock B is underpriced or both. e. Both stock A and stock B are correctly priced since stock A is riskier than stock B.

d. Either stock A is overpriced or stock B is underpriced or both.

A stock had returns of 4 percent, 11 percent, 16 percent, -6 percent, and -2 percent for the past five years. Based on these returns, what is the approximate probability that this stock will return at least 20 percent in any one given year? a. Less than .5 percent. b. Greater than .5 percent but less than 1 percent. c. Greater than 1 percent but less than 2.5 percent. d. Greater than 2.5 percent but less than 16 percent. e. Greater than 16.0 percent.

d. Greater than 2.5 percent but less than 16 percent.

Aimee is the owner of a stock with annual returns of 27 percent, -32 percent, 11 percent, and 23 percent for the past four years. She thinks the stock may be able to achieve a return of 50 percent or more in a single year. What is the probability that your friend is correct? a. Less than .5 percent. b. Greater than .5 percent but less than 1 percent. c. Greater than 1 percent but less than 2.5 percent. d. Greater than 2.5 percent but less than 16 percent. e. Greater than 16 percent

d. Greater than 2.5 percent but less than 16 percent.

A stock had returns of 14 percent, 13 percent, -10 percent, and 7 percent for the past four years. Which one of the following best describes the probability that this stock will lose no more than 10 percent in any one year? a. Greater than .5 but less than 1.0 percent. b. Greater than 1 percent but less than 2.5 percent. c. Greater than 2.5 percent but less than 16 percent. . d. Greater than 84 percent but less than 97.5 percent. e. Greater than 95 percent.

d. Greater than 84 percent but less than 97.5 percent.

Over the past five years, a stock produced returns of 11 percent, 14 percent, 4 percent, -9 percent, and 5 percent. What is the probability that an investor in this stock will not lose more than 10 percent in any one given year? a. Greater than .5 but less than 1.0 percent. b. Greater than 1 percent but less than 2.5 percent. c. Greater than 2.5 percent but less than 16 percent. d. Greater than 84 percent but less than 97.5 percent. e. Greater than 95 percent.

d. Greater than 84 percent but less than 97.5 percent.

The historical record for the period 1926-2010 supports which one of the following statements? a. A higher-risk security will provide a higher rate of return next year than will a lower-risk security. b. If you need a stated amount of money next year, your best investment option today for those funds would be long-term government bonds. c. Increased long-run potential returns are obtained by lowering risks. d. It is possible for small-company stocks to more than double in value in any one given year. e. Inflation was positive each year throughout the period of 1926-2010.

d. It is possible for small-company stocks to more than double in value in any one given year.

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.

What was the average rate of inflation over the period of 1926-2010? a. less than 2.0 percent b. between 2.0 and 2.5 percent c. between 2.5 and 3.0 percent d. between 3.0 and 3.5 percent e. greater than 3.5 percent

d. between 3.0 and 3.5 percent

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

d. geometric

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.

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.

Which of the following statements related to market efficiency tend to be supported by current evidence? I. Markets tend to respond quickly to new information. II. It is difficult for investors to earn abnormal returns. III. Short-run prices are difficult to predict accurately based on public information. IV. Markets are most likely weak form efficient. a. I and III only b. II and IV only c. I and IV only d. I, III, and IV only e. I, II, and III only

e. I, II, and III only

Which of the following correspond to a wide frequency distribution? I. relatively low risk II. relatively low rate of return III. relatively high standard deviation IV. relatively large risk premium a. II only b. III only c. I and II only d. II and III only e. III and IV only

e. III and IV only

A stock had annual returns of 4.8 percent, -11.6 percent, 18.2 percent, and 7.4 percent over the past four years. Which one of the following best describes the probability that this stock will produce a return of 30percent or more in a single year? a. 99 percent or more b. 95 percent or more c. Less than .5 percent d. Less than 1 percent but more than .5 percent e. Less than 2.5 percent but more than .5 percent

e. Less than 2.5 percent but more than .5 percent

Which one of the following best defines the variance of an investment's annual returns over a number of years? a. The average squared difference between the arithmetic and the geometric average annual returns. b. The squared summation of the differences between the actual returns and the average geometric return. c. The average difference between the annual returns and the average return for the period. d. The difference between the arithmetic average and the geometric average return for the period. e. The average squared difference between the actual returns and the arithmetic average return.

e. The average squared difference between the actual returns and the arithmetic average return.

Which one of the following categories of securities had the lowest average risk premium for the period 1926-2010? a. long-term government bonds b. small company stocks c. large company stocks d. long-term corporate bonds e. U.S. Treasury bills

e. U.S. Treasury bills

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.