Finance 626 exam 1

_____ of the investment banking firm Drexel Burnham Lambert was instrumental in convincing institutional investors that junk-bond yields were worth the risk, and thus was born the junk-bond market. Henry Kravis Michael Milken T. Boon Pickens Michael Burnham Marc Roberts

Michael Milken Relying on historical studies that showed risky bonds yielded more than enough to compensate for their risk, Michael Milken convinced institutional investors that junk-bond yields were worth their risk, and thus was born the junk-bond market.

How much would $100, growing at 5% per year, be worth after 75 years? $3,883.27 $4,281.30 $3,689.11 $4,077.43 $4,495.37

$3,883.27 - use financial calculator

What is the present value (t = 0) of the following cash flows if the discount rate is 12%? $4,440.51 $4,041.23 $4,782.43 $4,221.79 $3,997.98

$4,440.51 - solution said excel and cash flows

You buy 20 shares of Stock A for $50 each. The stock pays no dividends, but after one year, you sell all of the shares for a total of $1,060. What is the dollar return on your total investment? $6 $30 $60 $3 $160

$60 $1,060 - (20 x $50) = $1,060 - $1,000 = $60.

Taggart Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a −28% return. What is the firm's expected rate of return? 9.41% 9.65% 9.90% 10.15% 10.40%

9.90% .5*.25+.3*.1+.2*(-.28)=.099 = 9.90%

Which of the following statements regarding bonds is accurate? A bond is a long-term contract under which the issuer receives payments of interest and principal, on specific dates, from the holders of the bond. A bond is a short-term contract under which the holder agrees to make monthly payments of interest and principal to the issuer of the bond. A bond is a short-term contract under which a borrower agrees to make a payment of interest and principal, on a specific date, to the holder of the bond. A bond is a long-term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond. A bond is a long-term contract under which the holder agrees to make payments of interest and principal, on specific dates, to the issuer of the bond.

A bond is a long-term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond.

Which of the following statements regarding stock market performance since the 1970s is NOT accurate? Market returns decreased somewhat in the 1980s. Stocks have had positive returns in most years. Stock performance since the mid-1990s has been a roller coaster. The market was relatively flat in the 1970s. There have been several years with very large losses.

Market returns decreased somewhat in the 1980s.

Which of the following statements regarding today's stock trading is NOT accurate? Less than 12% of the total dollar volume of trading now takes place at the NYSE. Most stock trading is executed with automated trading platforms. Although listings are still concentrated at the NYSE and NASDAQ, a company's shares can and do trade at many different venues. Most stock trading is still conducted face-to-face at the NYSE. Less than 19% of the total dollar volume of trading now takes place at the NASDAQ.

Most stock trading is still conducted face-to-face at the NYSE.

prior to 1970, there was just one major U.S. stock exchange, which was the _____, where the vast majority of stocks were listed and traded. NASDAQ ASE NYSE MKT SEC NYSE

NYSE Before 1970, there was just one major U.S. stock exchange, the NYSE, where the vast majority of stocks were listed and traded.

Which of the following statements accurately describes business organizations? Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy. A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be paid by the partners rather than by the firm itself. In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business. A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company.

Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.

Which of the following events associated with a market bubble is NOT stated accurately? The volume of trading is much higher than past volume. Many new investors eagerly enter the market. After a run-up of prices, the prices suddenly fall precipitously. Prices climb slowly to heights that would have been considered unlikely before the run-up. Many of the new investors are left with huge losses.

Prices climb slowly to heights that would have been considered unlikely before the run-up.

When estimated from past data, the standard deviation is often denoted by: H. T. S. PD. SD.

S

The weight of an asset in a portfolio is: its dollar value divided by the total value of the portfolio. its dollar value divided by the total value of the portfolio multiplied by its risk factor. its designated risk factor. its dollar value. the return it has provided divided by the total return on the portfolio.

its dollar value divided by the total value of the portfolio. The weight of an asset in a portfolio is the percentage of the portfolio's total value that is invested in the asset.

Investors tend to hold risky losing investments instead of selling them and accepting a certain loss, which is a display of: hindsight bias. anchoring bias. herding behavior. self-attribution bias. loss aversion.

loss aversion Losses are so painful that people will make irrational choices to avoid sure losses. This phenomenon is called loss aversion.

Corporations are said to have an agency problem because: managers hired to act on behalf of shareholders may act in their own best interests instead. the firm's owners determine the strategy for managers to follow. there are too many government regulations restricting corporate strategy. managers have too many stakeholders to please. the board of directors manages day-to-day operations for shareholders.

managers hired to act on behalf of shareholders may act in their own best interests instead.

A company can list its stock: only at two stock exchanges. only at a single SEC-registered stock exchange. at up to three stock exchanges. at as many stock exchanges as it wishes, depending on the size of the issue. only at a single stock exchange, not necessarily SEC-registered.

only at a single SEC-registered stock exchange.

Wheat is traded in which type of market? financial assets market capital market consumer credit market physical assets market primary market

physical assets market Physical asset markets (also called "tangible" or "real" asset markets) are those for such products as wheat, autos, real estate, computers, and machinery.

A company's intrinsic value is: the present value of the firm's stockholders' equity, discounted at the weighted average cost of capital. the present value of the firm's expected annual sales, discounted at the weighted average cost of capital. the present value of the firm's expected free cash flows, discounted at the current prime rate of credit. the present value of the firm's expected free cash flows, discounted at the weighted average cost of capital. the difference between the firm's assets and liabilities.

the present value of the firm's expected free cash flows, discounted at the weighted average cost of capital.

A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. One example is a commercial bank, which takes in demand deposits and then uses that money to make long-term mortgage loans. True False

true A financial intermediary matches those who need money with those who supply it.

Shareholders of closely held stock cannot subsequently sell their shares to the general public. True False

true Government regulations restrict the number and type of investors that can buy closely held stock..

If companies fail to choose actions that maximize shareholder wealth, they can be sued by shareholders. True False

true Maximizing shareholder wealth is a fiduciary duty for most U.S. corporations. If companies fail in this duty, they can be sued by shareholders.

The CAPM does a very good job of explaining stock returns when news is announced that affects almost all companies, such as government reports regarding interest rate policy, inflation, and unemployment. True False

true Professors Savor and Wilson tested this hypothesis and found an extremely strong relationship between betas and stock returns on announcement days.

If the Federal Reserve Board wants to stimulate the economy, it most often: issues more security-backed mortgages through Fannie Mae. prints more money. uses open market operations to purchase Treasury securities held by banks. raises the prime interest rate. reduces taxes.

uses open market operations to purchase Treasury securities held by banks.

With which of the following correlations between two stocks would diversification eliminate all risk? 0.0 +0.3 +0.5 -1.0 +1.0

-1.0 The returns of two stocks having a correlation of -1 (the lowest possible correlation) would move in opposite directions of each other; one stock's low return would be offset by the other's high return, which would eliminate all risk.

You are managing a portfolio of 10 stocks that are held in equal dollar amounts. The current beta of the portfolio is 1.8, and the beta of Stock A is 2.0. If Stock A is sold and the proceeds are used to purchase a replacement stock, what does the beta of the replacement stock have to be to lower the portfolio beta to 1.7? 1.3 1.2 1.1 1.4 1.0

1.0 First, find the beta of the remaining 9 stocks: 1.8 = 0.9(bR) + 0.1(bA) 1.8 = 0.9(bR) + 0.1(2.0) 1.8 = 0.9(bR) + 0.2 1.6 = 0.9(bR)bR = 1.7778 Now, find the beta of the new stock that produces bp = 1.7: 1.7 = 0.9(1.7778) + 0.1(bN) 1.7 = 1.6 + 0.1(bN) 0.1 = 0.1(bN) bN = 1.0

Jan Middleton owns a 3-stock portfolio with a total investment value equal to $300,000. What is the weighted average beta of Jan's 3-stock portfolio? Stock Investment Beta A 100,000 0.5 B 100,000 1 C 100,000 1.5 Total: 300,000 1.3 1.0 0.4 0.9 1.2

1.0 The calculation of the portfolio's beta is as follows: bp = (1/3)(0.5) + (1/3)(1.0) + (1/3)(1.5) = 1.0.

A stock has a required return of 12%, the risk-free rate is 6%, and the market risk premium is 5%. What is the stock's beta coefficient? 0.95 1.20 1.50 0.80 1.75

1.2 r = 12%; rRF = 6%; RPM = 5%; b = ? r = rRF + (rM - rRF)b 12% = 6% + (5%)b 6% = 5%b b = 1.20

The Apple Investment Fund has a total investment of $450 million in five stocks. What is the fund's overall, or weighted average, beta? Stock Investment Beta 1 $130 0.4 2 110 1.5 3 70 3.0 4 90 2.0 5 50 1.0 Total: 450 1.22 1.35 1.46 1.14 1.53

1.46 (130/450)0.4 + (110/450)1.5 + (70/450)3.0 + (90/450)2.0 + (50/450)1.0 = 1.46.

Given the following historical returns for a company, what is the standard deviation? Year 1: 10%; Year 2: -5%; Year 3: 15%. 8.3% 10.4% 10.5% 6.7% 15.0%

10.4% Using Excel functions: =STDEV(0.10,-0.05,0.15) = 10.4%.

Consider the following information for the Alachua Retirement Fund. The fund has total investments of $4 million, the market required rate of return is 12%, and the risk-free rate is 6%. What is the fund's required rate of return? Stock Investment Beta A $400 1.2 B 600 -.04 C 1,000 1.5 D 2,000 0.8 Total: 4,000 10.45% 11.01% 11.50% 9.98% 12.56%

11.01% Determine the weight each stock represents in the portfolio, and multiply that by each beta, and then add them together to get the portfolio beta, which is bp = 0.8350 = Portfolio beta. Then, write out the SML equation, and substitute known values including the portfolio beta. Solve for the required portfolio return: RP = rRF + (rM - rRF)bp = 6% + (12% - 6%)0.8350 = 6% + 5.01% = 11.01%.

If rRF = 5%, rM = 11%, and b = 1.3 for Stock X, what is rX, the required rate of return for Stock X? 16.7% 14.8% 12.8% 18.7% 11.9%

12.8% rX = rRF + (rM - rRF)bX = 5% + (11% - 5%)1.3 = 12.8%.

If rRF = 5%, rM = 11%, and b = 1.3 for Stock X, what would rX be if investors expected the inflation rate to increase by 2 percentage points? Assume that investors' risk aversion has not changed. 16.7% 14.8% 12.8% 18.7% 11.9%

14.8% rX = rRF + (rM - rRF)bX = 7% + (13% - 7%)1.3 = 14.8%. A change in the inflation premium does not change the market risk premium (rM - rRF) as both rM and rRF are affected. Changes in the market risk premium reflect changes in investors' risk aversion.

The Apple Investment Fund has a total investment of $450 million in five stocks. If the risk-free rate is 12% and the market risk premium is 6%, what is the required rate of return on the Apple Fund? Stock Investment Beta 1 $130 0.4 2 110 1.5 3 70 3.0 4 90 2.0 5 50 1.0 Total: 450 19.92% 18.81% 17.62% 20.76% 15.77%

20.76% (130/450)0.4 + (110/450)1.5 + (70/450)3.0 + (90/450)2.0 + (50/450)1.0 = 1.46. RP = rRF + (rM - rRF)bp = 12% + (6%)1.46 = 20.76%.

If you pay $1,000 for a vacation package this year and the inflation rate is 2%, the same package will likely cost $1,020 next year. If you invest $1,000 today at 5%, you will have $1,050 next year from your investment. What is the real rate of return on your investment? 2% 3% 5% 20% 30%

3% $1,050 - $1,020 = $30 in terms of additional purchasing power; $30/$1,000 = 3%.

Stock A has a beta of 1.2, Stock B has a beta of 0.6, the expected rate of return on an average stock is 12%, and the risk-free rate of return is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? 3.25% 3.00% 2.50% 4.00% 3.75%

3.00% We know bA = 1.20, bB = 0.60; rM = 12%, and rRF = 7%. ri = rRF + (rM - rRF)bi = 7% + (12% - 7%)bi rA = 7% + 5%(1.20) = 13.0% rB = 7% + 5%(0.60) = 10.0% rA - rB = 13% - 10% = 3%.

Alpha Company's estimated beta is 1.3. This means that Alpha contributes_____ to a well-diversified portfolio, assuming all stocks in the portfolio have approximately the same weight. 1.3% more risk 30% less risk 30% more risk 1.3% less risk 70% less risk

30% more risk By definition, the average beta for all stocks is equal to 1, so Alpha contributes 30% more risk to a well-diversified portfolio than does a typical stock (assuming they have the same portfolio weight).

A reasonably well-diversified portfolio is defined as one containing at least _____ or more stocks in a number of different industries. 10 20 40 5 100

40 Almost half of the risk inherent in an average individual stock can be eliminated if the stock is held in a reasonably well-diversified portfolio, which is one containing 40 or more stocks in a number of different industries.

Stock A has the following probability distribution of expected returns. What is Stock A's expected rate of return and standard deviation? Probability Rate of Return .1 -15% .2 0% .4 5% .2 10% .1 25% 8.0%; 6.5% 5.0%; 3.5% 5.0%; 6.5% 8.0%; 9.5% 5.0%; 9.5%

5.0%; 9.5% rA = 0.1(-15%) + 0.2(0%) + 0.4(5%) + 0.2(10%) + 0.1(25%) = 5.0%. Variance = 0.1(-0.15 - 0.05)2 + 0.2(0.0 - 0.05)2 + 0.4(0.05 - 0.05)2 + 0.2(0.10 - 0.05)2 + 0.1(0.25 - 0.05)2 = 0.009. Standard deviation = 0.0949 = 9.5%.

Porter Inc.'s stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium? 5.95% 6.09% 6.25% 5.80% 6.40%

5.80% SML equation: rs = rRF + bStock × RPM 12.25% = 5.00% + 1.25 × RPM 7.25% = RPM × 1.25 5.80% = RPM

You buy 20 shares of Stock A for $50 each. The stock pays no dividends, but after one year, you sell all of the shares for a total of $1,060. What is the rate of return on your total investment? 6% 16% 30% 3% 60%

6% $1,060 - (20 x $50) = $1,060 - $1,000 = $60; $60 ÷ $1,000 = 6%.

Given the following historical returns for a company, what is the estimated average? Year 1: 10%; Year 2: -5%; Year 3: 15%. 6.7% 8.3% 20.0% 6.0% 25.0%

6.7% (10% - 5% + 15%) ÷ 3 = 6.7%.

Consider a $200,000 30-year mortgage with monthly payments. If the interest is 7.5% with monthly compounding, what portion of the mortgage payments during the first year will go toward interest? 100% 65% 89% 75% 95%

89% This loan has a monthly interest rate of 7.5/12 = 0.625% and will last for 12 x 30 = 360 months. Using that information, find the amount of the payment. PV = $200,000, FV = 0, I = .625%, and N=360; so PMT = $1,398.43. Using this, set up an amortization schedule in Excel: We can use this to determine how much interest was paid and what proportion of the total amount was paid.

Dothan Inc.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return. What is the firm's expected rate of return? 7.72% 8.12% 8.55% 9.00% 9.50%

9.0% (.25)(.3)+(.5)(.12)+(.25)(-.18)=.09

You have been managing a $3 million portfolio. The portfolio has a beta of 1.10 and a required rate of return of 10%. The current risk-free rate is 5.6%. Assume that you receive another $600,000. If you invest the money in a stock that has a beta of 0.60, what will be the required return on your $3.6 million portfolio? 9.67% 8.75% 9.95% 9.20% 10.20%

9.67% Step 1: Determine the market risk premium from the CAPM: .10 = .0056 + (rm-rfr)1.10 (rm-rfr)= .04 Step 2: Calculate the beta of the new portfolio ($600,000/$3,600,000)(.60)+($3,000,000/$3,600,000)(1.10)= 1.01667 Step 3: Calculate the required rate of return on the new portfolio: 5.6%+(4%)(1.01667) = 9.67%

Which of the following statements about business organizations is CORRECT? A significant risk in starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business. It's unlikely for a firm to be organized as a corporation when it requires a lot of capital. If a corporation elects to be taxed as a P corporation, then both it and its stockholders can avoid all federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. It is generally easier to transfer one's ownership interest in a partnership than in a corporation. Tax advantages of incorporation offset the corporate shareholders' exposure to unlimited liability.

A significant risk in starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.

A(n) _____ is a for-profit business with a charter that includes mandates to help the environment and society. P-corp S corporation B-corp PA PC

B-corp In a recent development, some U.S. corporations are choosing a new corporate form called a benefit corporation (B-corp), which expands directors' fiduciary responsibilities to include interests other than shareholders' interests.

Which of the following statements is correct? The slope of the SML is determined by the value of beta. If investors become less risk averse, the slope of the Security Market Line will increase. The SML relates required returns to firms' market risk. The slope and intercept of this line can be controlled by the financial manager. If you plotted the returns of a given stock against those of the market, and if you found that the slope of the regression line was negative, then the CAPM would indicate that the risk-free rate of return on the stock should be less than the required rate of return for a well-diversified investor, assuming that the observed relationship is expected to continue on into the future. Both the SML and a company's position on it change over time due to changes in interest rates, investors' aversion to risk, and individual companies' betas.

Both the SML and a company's position on it change over time due to changes in interest rates, investors' aversion to risk, and individual companies' betas. The slope (rM - rRF) and intercept (rRF) of the SML cannot be controlled by the financial manager. The slope of the SML is rM rRF not beta. A negative beta in the CAPM would indicate that the stock's required rate of return is less than the risk-free rate. Finally, if investors become less risk averse, the slope of the SML will decline, not increase.

The four most fundamental factors affecting the supply and demand of capital and the resulting cost of money include all of the following EXCEPT: risk. Federal Reserve Policy. inflation. production opportunities. time preferences for consumption.

Federal Reserve Policy. The four most fundamental factors affecting the supply and demand of capital and the resulting cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation.

Which of the following statements is correct? The slope of the SML is determined by the value of beta. If you plotted the returns of a given stock against those of the market, and if you found that the slope of the regression line was negative, then the CAPM would indicate that the risk-free rate of return on the stock should be less than the required rate of return for a well-diversified investor, assuming that the observed relationship is expected to continue on into the future. If investors become less risk averse, the slope of the Security Market Line will increase. The SML relates required returns to firms' market risk. The slope and intercept of this line can be controlled by the financial manager. Both the SML and a company's position on it change over time due to changes in interest rates, investors' aversion to risk, and individual companies' betas.

Both the SML and a company's position on it change over time due to changes in interest rates, investors' aversion to risk, and individual companies' betas. The slope (rM - rRF) and intercept (rRF) of the SML cannot be controlled by the financial manager. The slope of the SML is rM rRF not beta. A negative beta in the CAPM would indicate that the stock's required rate of return is less than the risk-free rate. Finally, if investors become less risk averse, the slope of the SML will decline, not increase.

_____ is widely used to estimate the required return on a company's stock and, hence, should be used to estimate the required returns that a company's projects must generate to provide the stock's required return. EMH SML FCF CAPM WACC

CAPM

Bethany is planning to start a business. Why might she choose to operate her business as a corporation rather than as a proprietorship or a partnership? A smaller amount of a corporation's income is generally subject to federal taxes. Corporations generally face fewer regulations. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. Corporate investors are exposed to unlimited liability. Corporations generally find it easier to raise large amounts of capital.

Corporations generally find it easier to raise large amounts of capital. Outsiders who are thinking about investing in a business are generally not willing to be subjected to unlimited liability, and they also want to be able to sell their shares should they choose to do so. Corporations provide these advantages; hence, firms that need large amounts of capital that must be raised in capital markets generally choose to incorporate.

In response to the economic crisis of 2007, Congress passed the _____ as an attempt to prevent the next crisis. Emergency Economic Stabilization Act (EESA) Dodd-Frank Wall Street Reform and Consumer Protection Act American Recovery and Investment Act Troubled Asset Relief Plan (TARP) Glass-Steagall Act

Dodd-Frank Wall Street Reform and Consumer Protection Act congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 as an attempt to prevent a repeat of the 2007 economic crisis.

Which of the following represents a significant disadvantage to the corporate form of organization? Difficulty in transferring ownership. Exposure to taxation of corporate earnings and stockholder dividend income. Degree of liability to which corporate owners and managers are exposed. Level of difficulty corporations face in obtaining large amounts of capital in financial markets. All of the above are disadvantages to the corporate form of organization.

Exposure to taxation of corporate earnings and stockholder dividend income.

Which of the following statements describes a primary market transaction? You sell 200 shares of Kroger stock on the NYSE through your broker. Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker. You buy 200 shares of Honda stock from your brother. The trade is not made through a broker; you just give him cash and he gives you the stock. One financial institution buys 200,000 shares of BP stock from another institution. An investment banker arranges the transaction. Microsoft sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years.

Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker. A primary market transaction is one that brings an asset to the public markets for the first time.

A small standard deviation means that possible outcomes are widely dispersed, whereas a large standard deviation means that outcomes are more tightly clustered. True False

False

The acronym IPO stands for "independent public offering." True False

False "IPO" stands for "initial public offering," which is the process for introducing a company to the public markets.

A stock with a beta greater than 1 has stock returns that tend to be lower than the market when the market is up but tend to be higher than the market when the market is down.. True False

False A stock with a beta greater than 1 has stock returns that tend to be higher than the market when the market is up but tend to be below the market when the market is down.

When sub-prime market mortgages began defaulting, insurance companies such as AIG, the largest backer of credit default swaps, were the first to fall. False. True.

False Mortgage companies were the first to fall. Many originating firms had not sold all of their sub-prime mortgages, and they failed.

The Fama-French three-factor model is useful when it comes to estimating the required return on a stock because the model provides a well-accepted link between risk and required return. True False

False The model is less useful when it comes to estimating the required return on a stock because the model does not provide a well-accepted link between risk and required return.

Which of the following statements regarding secondary markets is NOT true? Secondary markets provide liquidity for investors who need cash or who wish to reallocate their investments to potentially more productive opportunities. If a public company sells a second issue of common stock to raise capital, it will do so in the secondary market. Secondary markets foster entrepreneurship. The company whose securities are being traded is not involved in a secondary market transaction and thus does not receive any funds from such a sale. Secondary markets provide a measure of value as perceived by buyers and sellers, making it easy to quickly compare different investments.

If a public company sells a second issue of common stock to raise capital, it will do so in the secondary market.

Which of the following statements regarding the actions taken by the government in response to the economic crisis of 2007 is NOT accurate? Congress passed EESA, which allowed the U.S. Treasury to purchase preferred stock in banks. In 2010, the government temporarily raised Social Security taxes to provide funding for stimulus projects. Congress passed TARP, which authorized the U.S. Treasury to purchase mortgage-related assets from financial institutions. The American Recovery and Investment Act of 2009 provided funding for direct stimulus spending for a variety of federal projects and aid for state projects. TARP and EESA were modified so that the Treasury could make loans to GM and Chrysler.

In 2010, the government temporarily raised Social Security taxes to provide funding for stimulus projects.

Which of the following statements regarding the actions taken by the government in response to the economic crisis of 2007 is NOT accurate? TARP and EESA were modified so that the Treasury could make loans to GM and Chrysler. Congress passed TARP, which authorized the U.S. Treasury to purchase mortgage-related assets from financial institutions. The American Recovery and Investment Act of 2009 provided funding for direct stimulus spending for a variety of federal projects and aid for state projects. In 2010, the government temporarily raised Social Security taxes to provide funding for stimulus projects. Congress passed EESA, which allowed the U.S. Treasury to purchase preferred stock in banks.

In 2010, the government temporarily raised Social Security taxes to provide funding for stimulus projects. In 2010, the government temporarily cut Social Security taxes from 6.2% to 4.2% to help stimulate the economy.

Which of the following causes of the sub-prime mortgage meltdown is NOT stated accurately? Home buyers purchased homes they could not afford with "option ARM" loans, expecting that they could resell or refinance the loans before the monthly payment amount adjusted upward. Investors frequently purchased a type of insurance policy on a mortgage-backed security called a debit no-fault swap, which wasn't really insurance. Regulators approved sub-prime standards. Real estate appraisers were lax, because they assumed home values would continue to go up. Mortgage brokers didn't care if home buyers defaulted eventually, because they did not retain a vested interest in the loans they originated.

Investors frequently purchased a type of insurance policy on a mortgage-backed security called a debit no-fault swap, which wasn't really insurance.

In what way did the Fed contribute to the housing bubble in the 2000s? It relaxed regulations regarding the home buyer's minimum income relative to mortgage size. It raised interest rates. It slashed interest rates to historic lows and kept them low for a long time. It relaxed regulations so that subprime mortgages could be securitized. It relaxed regulations regarding the minimum down payment for a home buyer.

It slashed interest rates to historic lows and kept them low for a long time.

Which of the following statements regarding the Volcker Rule is NOT accurate? Implementation of the Volcker Rule was postponed several times, and as of early 2017 had not been fully implemented. The Volcker Rule would greatly limit a bank's proprietary trading, such as investing the bank's own funds into hedge funds, with the idea of preventing banks from making highly leveraged bets on risky assets. The Volcker Rule was named after former fed chairman Paul Volcker. Some large banks, such as Goldman Sachs and Morgan Stanley, increased their proprietary trading operations in anticipation of the implementation of the Volcker Rule. The Volcker Rule is part of the Dodd-Frank Act.

Some large banks, such as Goldman Sachs and Morgan Stanley, cut back their proprietary trading operations in anticipation of the implementation of the Volcker Rule.

If investors expected inflation to increase in the future, and they also became more risk averse, what could be said about the change in the Security Market Line (SML)? The SML would shift up and the slope would decrease. The SML would shift down and the slope would increase. The SML would shift down and the slope would decrease. The SML would shift up and the slope would increase. The SML would remain unchanged.

The SML would shift up and the slope would increase.

Which of the following statements regarding the mortgage-securitization process is NOT accurate? Investment banks bundle the mortgages and use them to back securities that can be traded in financial markets. The banks, S&Ls, and specialized mortgage-originating firms can use the cash they receive from selling mortgages to make additional loans to other aspiring homeowners. Congress facilitated the mortgage-securitization process by creating two stockholder-owned but government-sponsored entities, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Banks, S&Ls, and specialized mortgage-originating firms can originate mortgages and then sell them to investment banks. The banks, S&Ls, and specialized mortgage-originating firms maintain the risk of mortgage default.

The banks, S&Ls, and specialized mortgage-originating firms maintain the risk of mortgage default. The banks, S&Ls, and specialized mortgage-originating firms pass the risk of mortgage default to the investment bank, which in turn passes it on to the investors of the mortgage-backed securities.

In a portfolio of three different stocks, which of the following could NOT be true? The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. The beta of the portfolio is less than the beta of each of the individual stocks. The beta of the portfolio is greater than the beta of one or two of the individual stocks. The riskiness of the portfolio is less than the riskiness of each stock held in isolation. The beta of the portfolio is equal to the beta of one of the individual stocks.

The beta of the portfolio is less than the beta of each of the individual stocks. The beta of the portfolio is a weighted average of the individual securities' betas, so it could not be less than the betas of all of the stocks.

What if an investor wants to buy 1,000 shares of Apple at the market price, but the NBBO ask price of $100.02 is for only 200 shares? The first 200 shares will be sold at $100.02 after which a new NBBO price will be calculated. The NBBO price will be ignored and the highest bid accepted. The NBBO price will be recalculated and all shares will be sold for the same price. All shares will be sold at $100.02. The NBBO price will be ignored and the ask price will be accepted.

The first 200 shares will be sold at $100.02 after which a new NBBO price will be calculated. In this case, 200 shares might be transacted at the current NBBO price of $100.02, after which the computer systems will announce a new NBBO price, which might be for 100 shares at $100.07. The process would be repeated until the market order to buy 1,000 shares is completed.

Which of the following statements regarding collateralized debt obligations (CDOs) is NOT accurate? CDOs are the result of subdividing and recombining mortgage securities into different securities. The complexity of CDOs made it difficult for investors to assess the aggregate risk of a particular CDO. The process of creating CDOs reduced the overall risk embedded in securitized mortgages. Each time a new security was created and rated, fees were being earned by investment banks and rating agencies. None of these options is inaccurate.

The process of creating CDOs reduced the overall risk embedded in securitized mortgages. The CDO process didn't change the total amount of risk embedded in the mortgages, but it did make it possible to create some securities that were less risky than average and some that were more risky.

The graph of a normal distribution will typically have: a downward sloping curve. roller coaster (multiple up and down) curves. a nearly flat curve. an upward sloping curve. a bell-shaped curve.

a bell-shaped curve The normal distribution, with its familiar bell-shaped curve, is widely used in many areas, including finance.

Which of the following statements regarding the Fama-French three-factor model is NOT accurate? To form the second factor, Fama and French ranked all actively traded stocks by size and then divided them into two portfolios, one consisting of small stocks and one consisting of big stocks. As part of the second factor, Fama and French created a third portfolio called the SMB (small minus big) portfolio, which is designed to measure the variation in stock returns that is caused by the size effect. To form the third factor, Fama and French ranked all stocks according to their book-to-market (B/M) ratios. They placed the 35% of stocks with the highest ratios into a portfolio they called the H portfolio (for high B/M ratios) and placed the 35% of stocks with the lowest ratios into a portfolio called the L portfolio (for low B/M ratios). The first factor in the Fama-French three-factor model is the market risk premium, which is the market return, rM, minus the risk-free rate, rRF. As part of the third factor, Fama and Frank subtracted the return of the L portfolio from that of the H portfolio to derive the HML (high minus low) portfolio.

To form the third factor, Fama and French ranked all stocks according to their book-to-market (B/M) ratios. They placed the 35% of stocks with the highest ratios into a portfolio they called the H portfolio (for high B/M ratios) and placed the 35% of stocks with the lowest ratios into a portfolio called the L portfolio (for low B/M ratios). To form the third factor, Fama and French ranked all stocks according to their book-to-market (B/M) ratios. They placed the 30% of stocks with the highest ratios into a portfolio they called the H portfolio (for high B/M ratios) and placed the 30% of stocks with the lowest ratios into a portfolio called the L portfolio (for low B/M ratios).

Mortgage-backed securities are more liquid than individual mortgage loans. True False

True

Eugene Fama and Kenneth French developed the three-factor model because they found that beta was not useful in explaining returns. True False

True After taking into account the returns due to the company's size and B/M ratio, high-beta stocks did not have higher than average returns and low-beta stocks did not have lower than average returns.

Two investors each hold a portfolio, which is their only asset. Mr. Luca's portfolio has a beta of minus 2.0, while Ms. Johnson's portfolio has a beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then Mr. Luca and Ms. Johnson face the same amount of risk. However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some "normal" stocks with beta = 1.0. True False

True Both portfolios would be twice as risky as a portfolio of average stocks. Their risks would decline if they added b = 1.0 stocks, as those stocks would move the portfolios' betas toward 1.0.

Which of the following factors affect diversifiable risk but not market risk? inflation recession high interest rates war a strike

a strike Diversifiable risk is caused by events that are unique to a particular firm or industry (such as a strike) that can be offset through diversification.

Which of the following statements regarding SOX and Dodd-Frank is NOT accurate? If an employee is improperly fired or penalized for whistleblowing, the company can be required to reinstate the person along with back pay and a penalty reward. The Sarbanes-Oxley (SOX) Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act strengthened protection for whistleblowers who report financial wrongdoing. Under the Dodd-Frank Act, whistleblowers receive a percentage of the amount that the SEC fines the wrongdoing corporation, up to $1 million. The Sarbanes-Oxley (SOX) Act made it a criminal act for a CEO or CFO to knowingly falsely certify a company's financial position. Under Sarbanes-Oxley (SOX) Act, employees who report corporate financial wrongdoing and subsequently are penalized by the company can ask the Occupational Safety and Health Administration (OSHA) to investigate the situation.

Under the Dodd-Frank Act, whistleblowers receive a percentage of the amount that the SEC fines the wrongdoing corporation, up to $1 million. there is no cap on awards, which are based on a percentage of the amount that the SEC fines the wrongdoing corporation. The largest award was $30 million in 2014.

Which of the following statements regarding intrinsic stock value maximization and social welfare is accurate? More than 64% of all U.S. households directly own mutual funds, either directly or as part of a tax-deferred retirement account. When a manager takes actions to minimize intrinsic value, this improves the quality of life for millions of ordinary citizens. When direct stock ownership, mutual fund ownership, and indirect ownership through pension funds are considered, many members of society now have an important stake in the stock market. In general, unlawful actions taken to maximize intrinsic stock values actually benefit society. Value maximization requires efficient, low-cost businesses that produce high-quality goods and services that consumers need and want at the highest possible cost.

When direct stock ownership, mutual fund ownership, and indirect ownership through pension funds are considered, many members of society now have an important stake in the stock market.

Some broker-dealers provide a different trading venue in which buyers can trade directly with sellers. This is called: an alternative trading system (ATS). internalization. a high-frequency trading system (HFTS). an off-the-block trading system (OBTS). an over-the-counter system (OCS).

an alternative trading system (ATS). different trading venue provided by some broker-dealers in which buyers can trade directly with sellers is called an alternative trading system (ATS).

A continuous probability distribution has _____ outcomes. three possible 15 possible one hundred possible two possible an infinite number of

an infinite number of When the complexity of a situation can't be described adequately with several or even many scenarios, most analysts turn to continuous probability distributions, which have an infinite number of possible outcomes.

When the market is performing better than average, people tend to think it will continue to perform better than average. This is an example of: hindsight bias. anchoring bias. herding behavior. self-attribution bias. loss aversion.

anchoring bias Psychologists have learned that many people focus too closely on recent events when predicting future events, a phenomenon called anchoring bias.

Which of the following points would appear in a corporation's bylaws but not the charter? the types of activities the business will pursue the number of directors the names and addresses of directors the amount of capital stock to be issued how the directors are to be elected

how the directors are to be elected

A debt instrument that matures in more than a year is called a: derivative. capital market security. money market security. lease. common stock.

capital market security.

Which of the following financial instruments bears the greatest risk and therefore the highest rate of return? mortgages preferred stocks U.S. Treasury bills municipal bonds common stocks

common stock Common stocks bear the greatest risk and potentially the highest rate of return.

Which of the following goals of the Dodd-Frank Act is NOT accurately stated? separate banking from speculating head off and rein in systemic failures at too-big-to-fail banks decrease transparency and risk due to derivatives trading protect consumers from predators and themselves give regulators more oversight of hedge funds, credit-rating agencies, and to-big-to-fail institutions

decrease transparency and risk due to derivatives trading The Act sought to increase transparency and reduce risk due to derivatives trading.

In extreme situations, such as the debt ceiling crisis, the European bond crisis, oil supply threats, bank stress tests, and so on, investors will use the _____ approach to measure risk. discrete outcome (with multiple scenarios) double outcome (with best and worst scenarios) payoff stand-alone CAPM

discrete outcome (with multiple scenarios) Investors usually don't estimate discrete outcomes in normal economic times but instead use the scenario approach during special situations, such as the debt ceiling crisis, the European bond crisis, oil supply threats, bank stress tests, and so on. Even in these situations, they would estimate more than three outcomes.

Stockholders should expect to be compensated for both diversifiable risk and market risk. True False

false Stockholders should not expect to be compensated for the risk they can eliminate through diversification, only for the remaining market risk.

The professionals who manage mutual fund portfolios, on average, slightly outperform the overall stock market and tend to have returns that are slightly higher than predicted by the CAPM. True False

false The professionals who manage mutual fund portfolios, on average, do not outperform the overall stock market as measured by an index like the S&P 500 and tend to have returns lower than predicted by the CAPM, possibly because many mutual funds have high fees.

We can classify providers and users of cash into four general groups, which include all of the following EXCEPT: financial institutions. nonfinancial organizations. governments. individuals. for-profit businesses.

for-profit businesses. We can classify providers and users of cash into four groups: individuals, financial organizations (like banks and insurance companies), nonfinancial organizations (like Apple, Starbucks, and Ford), and governments. For-profit businesses fall under nonfinancial organizations.

High returns in mortgage-backed securities during 2004 and 2005 enticed other investors to move into that asset class. This is an example of: hindsight bias. anchoring bias. herding behavior. self-attribution bias. loss aversion.

herding behavior Herding behavior occurs when groups of investors emulate other successful investors and chase asset classes that are doing well.

In the three-factor equation, the variable ei,t represents: historical (realized) rate of return on Stock i in period t. dollar amount of return with interest rate i for time period t slope coefficients for Stock e. random error, reflecting the difference between the actual return on Stock i in period t and the return as predicted by the regression line. none of these.

random error, reflecting the difference between the actual return on Stock i in period t and the return as predicted by the regression line. The variable ei,t represents random error, reflecting the difference between the actual return on Stock i in period t and the return as predicted by the regression line.

When broker-dealers execute trades among themselves, it may be called any of the following EXCEPT a(n): broker-dealer trade. off-exchange transaction. over-the-counter (OTC) trade. registered stock exchange. none of these options are exceptions.

registered stock exchange. When broker-dealers execute trades among themselves, a registered stock exchange is bypassed.

The formula for determining a firm's free cash flows is: sales less operating costs. sales less operating costs and taxes less required investments in operating capital. sales less required investments in operating capital. sales less operating costs and taxes. the required investments in operating capital divided by net income.

sales less operating costs and taxes. FCF = Sales Revenues - Operating Costs and Taxes - Required Investments in Operating Capital.

Three years ago you purchased 500 shares in the Kellogg Company, but yesterday you sold 200 of those shares through your broker. This is a(n): secondary market transaction. over-the-counter market transaction. futures market transaction. primary market transaction. money market transaction.

secondary market transaction. Secondary markets involve securities and other financial assets traded among investors after they have been issued by corporations.

High-frequency trading (HFT) firms usually build or lease dedicated high-speed fiber-optic lines between their colocated computers at the different exchanges, which allows HFT computers to send and receive: 50 or 60 orders per second. 2 or 3 orders per second. several hundred orders per second. several thousand orders per second. 20 or 30 orders per second.

several hundred orders per second.

_____ is the risk an investor would face if he/she had only one asset. Averse risk Stand-alone risk Diversified risk Market risk Portfolio risk

stand-alone risk

The Efficient Markets Hypothesis (EMH) asserts: it is possible for an investor to "beat the market." it is possible to consistently earn a higher rate of return that is justified by a stock's risk. the market adjusts slowly to new information that affects a stock's intrinsic value. stocks are always in equilibrium. none of these options.

stocks are always in equilibrium The Efficient Markets Hypothesis (EMH) asserts: (1) Stocks are always in equilibrium. (2) It is impossible for an investor to "beat the market" and consistently earn a higher rate of return than is justified by the stock's risk.

Which of the following forms of EMH asserts that privately held information is reflected in current market prices? semistrong-form EMH strong-form EMH both weak-form and semistrong-form EMH weak-form EMH both semistrong-form and strong-form EMH

strong-form EMH The strong form of the EMH states that current market prices reflect all pertinent information, whether publicly available or privately held.

Factors that affect the weighted average cost of capital include all of the following EXCEPT: the firm's debt/equity mix. market interest rates. the firm's income tax rate. the firm's business risk. market risk aversion.

the firm's income tax rate. The weighted average cost of capital is affected by the cost of debt and the cost of equity, which in turn are affected by market interest rates, market risk aversion, the firm's debt/equity mix, and the firm's business risk.

A foreign trade deficit refers to: the level of exports being great than the level of imports. the increase in the federal debt. the level of imports being greater than the level of exports. a decrease in the currency exchange rate for the U.S. dollar against foreign currencies. the interest rates in other countries exceeding interest rates in the United States.

the level of imports being greater than the level of exports.