FINA 307 Study Guide - Exam 3

Specific risks are generally associated with a single firm or industry. True False

True

An increase in a firm's debt ratio will have no effect on the required rate of return for equity holders. True False

False

Beta measures the total risk of an individual security. True False

False

Market risk can be eliminated in a stock portfolio through diversification. True False

False

The risk that remains in a stock portfolio after efforts to diversify is known as unique risk. True False

False

According to the CAPM, a stock's expected return is positively related to its beta. True False

True

As a firm increases its debt ratio, debtholders... As a firm increases its debt ratio, debtholders are likely to demand higher rates of return. True False

True

Average returns on high-risk assets are higher than those on low-risk assets. True False

True

Beta measures a stock's sensitivity to market risks. True False

True

Both the capital asset pricing model and the dividend discount model can be used to determine the cost of equity financing. True False

True

Market risk premium is defined as the difference between the market rate of return and the return on risk-free Treasury bills. True False

True

The CAPM states that the expected risk premium on any security equals its beta times the market risk premium. True False

True

The WACC is the rate of return that the firm must expect to earn on its average-risk investments in order to provide an acceptable return to its security holders. True False

True

The company cost of capital is the expected rate of return that investors demand from the company's assets and operations. True False

True

The expected return on an investment provides compensation to investors both for waiting and for worrying. True False

True

The security market line displays the relationship between expected return and beta. True False

True

The company cost of capital: a. measures what investors require from the company. b. depends on current profits and cash flows. c. is measured using security book values. d. depends on historical profits and cash flows.

a

Which one of the following risks is most important to a well-diversified investor in common stocks? a. Market risk b. Unique risk c. Unsystematic risk d. Diversifiable risk

a

A stock's beta measures the: a. average return on the stock. b. variability in the stock's returns compared to that of the market portfolio. c. difference between the return on the stock and the return on the market portfolio. d. market risk premium on the stock.

b

Although unique risk is present in differing amounts, individual stocks are: a. exposed to the same amount of market risk. b. exposed to differing amounts of market risk also. c. not exposed to market risk; only the general economy is subject to market risk. d. able to diversify away their market risk.

b

The wider the dispersion of returns on a stock, the: a. lower the expected rate of return. b. higher the standard deviation. c. lower the real rate of return. d. lower the variance.

b

What is the typical relationship between the standard deviation of an individual common stock and the standard deviation of a diversified portfolio of common stocks? a. The individual stock's standard deviation will be lower. b. The individual stock's standard deviation will be higher. c. The standard deviations should be equal. d. There is no way to predict this relationship. e. References

b

What would you recommend to an investor who is considering an investment that, according to its beta, plots below the security market line? a. Invest; The return is high relative to the risk. b. Don't invest; The risk is high relative to the return. c. Invest; All stocks revert to the SML over time. d. Don't invest; All stocks below the SML are low-growth stocks.

b

Which one of the following risk types can be most eliminated by adding stocks to a portfolio? a. Systematic risk b. Unique risk c. Market risk d. Inflation rate risk

b

Which one of the following risks would be classified as a unique risk for an auto manufacturer? a. Interest rates b. Steel prices c. Business cycles d. Foreign exchange rates

b

Why do stock market investors seem to ignore unique risks when calculating expected rates of return? a. There is no method for quantifying unique risks. b. Unique risks are assumed to be diversified away. c. Unique risks are compensated by the risk-free rate. d. Beta includes a component to compensate for unique risk.

b

The slope of the security market line equals: a. one. b. beta. c. the market risk premium. d. the expected return on the market portfolio.

c

What is the beta of a U.S. Treasury bill? a. 1.0 b. -1.0 c. 0 d. Unknown

c

What will happen to a stock that offers a lower return than predicted by the CAPM? a. Its beta will increase. b. Its beta will decrease. c. Its market price will decrease causing its yield to increase. d. Its market price will increase causing its yield to increase.

c

A stock's risk premium is equal to the: a. expected market return times beta. b. Treasury bill yield plus the expected market return. c. risk-free rate plus the expected market risk premium. d. expected market risk premium times beta.

d

Risk factors that are expected to affect only a specific firm are referred to as: a. market risk. b. diversifiable risk. c. systematic risk. d. risk premiums.

d

The major benefit of diversification is the: a. increased expected return. b. removal of all negative risk assets from the portfolio. c. reduction in the portfolio's systematic risk. d. reduction in the portfolio's total risk.

d

The return on a security includes premiums for: a. market risk and unique risk. b. unique risk and firm-specific risk. c. diversification and portfolio risk. d. time value of money and market risk.

d

Which one of the following statements is more likely to be correct concerning the comment, "Stock A has a higher expected return than Stock B"? a. Stock A has more unique risk. b. Stock B plots below the security market line. c. Stock B is a cyclical stock. d. Stock A has a higher beta.

d

Which one of these is a specific risk? a. Revision to the corporate tax laws b. Inflation increase of 2.3% c. Reduction in the overall economic output d. Retirement of a company executive

d