Final

A firm's cost of capital should be used as the discount rate for every new project the firm considers

False

A project should be accepted if its return plots below the security market line

False

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

False

Diversification with an indefinitely large number of securities completely eliminates risk

False

Diversification works only when returns are uncorrelated

False

The CAPM is a theory of the relationship between risk and return that states that the expected risk premium on any security equals its beta times the market return

False

The risk of a diversified portfolio depends on the specific risk of the individual stocks

False

beta measures the total risk of an individual security

False; market

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?

The individual stock's standard deviation will be higher

Cyclical stocks tend to perform well when other stocks are performing well also

True

For a well-diversified portfolio, only market risk matters

True

If a low-risk company invests in a high-risk project, those cash flows should be discounted at a high cost of capital

True

If stocks were perfectly correlated, diversification would not reduce risk

True

Investors prefer diversified portfolios because they are less risky

True

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

True

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

True

The risk that you can't avoid no matter how much you diversify is known as market risk

True

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

True

The security market line provides a standard that can be used to make project acceptance/rejection decisions

True

There are two costs of debt finance. The explicit cost of debt is the rate of interest that bondholders demand. But there is also an implicit cost, because higher levels of debt increase the required rate of return to equity

True

What decision should be made on a project with above-average market risk?

Use a higher discount rate than the WACC to reflect the project's risk and accept if NPV is positive at this higher discount rate

To calculate the present value of a business, the firm's free cash flows should be discounted at the firm's

WACC

The benefits of portfolio diversification are highest when the individual securities within the portfolio have returns that:

are largely uncorrelated with the rest of the portfolio

If a security plots below the security market line, it is:

offering too little return to justify its risk

Capital structure decisions refer to the:

blend of equity and debt used by the firm

The major benefit of diversification is the:

reduction in the portfolio's total risk

A stock's beta measures the:

sensitivity of the stock's returns to those of the market portfolio

The slope of the line fitted to a plot of a stocks return versus the returns on the market reflects

specific risk of the stock

If the line measuring a stock's historic returns against the market's historic returns has a slope greater than 1.0, then the:

stock has a beta exceeding 1.0

The slope of the security market line equals:

the market risk premium

The company cost of capital may be an inappropriate discount rate for a capital budgeting proposal if:

the project has a different degree of risk from the company

The average of the betas for all stocks is

exactly 1.0; these stocks represent the market

macro events only are reflected in the performance of market portfolio becuase

the specific risks have been diversified away

The expected return on a security includes a reward for

time value of money and market risk

Which total risk can be diversified away as additional securities are added to a portfolio

total risk and firm specific risk

In a well diversified portfolio

unsystematic risk is negligible