Investments Final

You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a beta of 0.7. The beta of the resulting portfolio is A) 1.40 B) 1.15 C) 0.36 D) 1.08 E) 0.80

B. 0.5(1.6) + 0.5(0.70) = 1.15

Consider the single-factor APT. Stocks A and B have expected returns of 12% and 14%, respectively. The risk-free rate of return is 5%. Stock B has a beta of 1.2. If arbitrage opportunities are ruled out, stock A has a beta of __________. A. 0.67 B. 0.93 C. 1.30 D. 1.69 E. none of the above

B. 12% = 5% + bF; B: 14% = 5% + 1.2F; F = 7.5%; Thus, beta of A = 7/7.5 = 0.93.

If the annual real rate of interest is 5%, and the expected inflation rate is 4%, the nominal rate of interest would be approximately A. 1%. B. 9%. C. 20%. D. 15%.

B. 5% + 4% = 9%.

You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. 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 0.06? A. 30% and 70% B. 50% and 50% C. 60% and 40% D. 40% and 60% E. Cannot be determined.

C. 0.06 = x(0.15); x = 40% in risky asset.

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei) equal to 20% and 20 securities? A. 12.5% B. 625% C. 4.47% D. 3.54% E. 14.59%

C. 1/20+20^2=20^(1/2)=4.47

Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 16%. The risk-free rate of return is 5%. The stock earns a return that exceeds the risk-free rate by 11% and there are no firm-specific event affecting the stock performance. The β of the stock is _______. A) 0.67 B) 0.75 C) 1.0 D) 1.33 E) 1.50

C. 11% = 0% + b(11%); b = 1.0.

Assume you purchased 200 shares of GE common stock on margin at $70 per share from your broker. If the initial margin is 55%, how much did you borrow from the broker? A. $6,000 B. $4,000 C. $7,700 D. $7,000 E. $6,300

200 shares × $70/share × (1 - 0.55) = $14,000 × (0.45) = $6,300

Assume that a risk-averse investor owning stock in Miller Corporation decides to add the stock of either Mac or Green Corporation to her portfolio. All three stocks offer the same expected return and total variability. The correlation of return between Miller and Mac is −.05 and between Miller and Green is +.05. Portfolio risk is expected to: a. Decline more when the investor buys Mac. b. Decline more when the investor buys Green. c. Increase when either Mac or Green is bought. d. Decline or increase, depending on other factors.

A.

If information processing was perfect, many studies conclude that individuals would tend to make __________ decisions using that information due to __________. A. less than fully rational; behavioral biases B. fully rational; behavioral biases C. less than fully rational; fundamental risk D. fully rational; fundamental risk E. fully rational; utility maximization

A.

Other things being equal, a low ________ would be most consistent with a relatively high growth rate of firm earnings. A. dividend-payout ratio B. degree of financial leverage C. variability of earnings D. inflation rate

A.

A 9% coupon bond with an ask price of 100:00 pays interest every 182 days. If the bond paid interest 112 days ago, the invoice price of the bond would be A. $1,027.69. B. $1,027.35. C. $1,026.77. D. $1,027.98. E. $1,028.15.

A. $1,000 + [45 × (112/182)] = $1,027.69.

You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to A. 0.4667. B. 0.8000. C. 2.14. D. 0.41667. E. Cannot be determined.

A. (0.12 - 0.05)/0.15 = 0.4667.

According to Michael Porter, there are five determinants of competition. An example of _____ is the threat new competitors pose to existing competitors in an industry. A. threat of entry B. rivalry between existing competitors C. pressure from substitute products D. bargaining power of buyers E. bargaining power of suppliers

A. According to Michael Porter, there are five determinants of competition. An example of threat of entry is when new entrants to an industry put pressure on prices and profits.

An example of ________ is that a person may reject an investment when it is posed in terms of risk surrounding potential gains, but may accept the same investment if it is posed in terms of risk surrounding potential losses. A. framing B. regret avoidance C. overconfidence D. conservatism

A. An example of framing is that a person may reject an investment when it is posed in terms of risk surrounding potential gains, but may accept the same investment if it is posed in terms of risk surrounding potential losses.

The first major step in asset allocation is A. assessing risk tolerance. B. analyzing financial statements. C. estimating security betas. D. identifying market anomalies.

A. Assessing risk tolerance should be the first consideration in asset allocation. The other options refer to security selection.

Fly Boy Corporation is expected have EBIT of $800k this year. Fly Boy Corporation is in the 30% tax bracket, will report $52,000 in depreciation, will make $86,000 in capital expenditures, and will have a $16,000 increase in net working capital this year. What is Fly Boy's FCFF? A. 510,000 B. 406,000 C. 542,000 D. 596,000 E. 682,000

A. FCFF = EBIT(1 - T) + depreciation capital expenditures increase in NWC or 800,000(.7) + 52,000 86,000 16,000 = 510,000.

A firm's earnings per share increased from $10 to $12, dividends increased from $4.00 to $4.80, and the share price increased from $80 to $90. Given this information, it follows that A. the stock experienced a drop in the P/E ratio. B. the firm had a decrease in dividend-payout ratio. C. the firm increased the number of shares outstanding. D. the required rate of return decreased.

A. PE= 80/10=8, 𝐴𝑁𝐷 90/12 = 7.5

The capital allocation line can be described as the 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.

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.

In words, the real rate of interest is approximately equal to A. the nominal rate minus the inflation rate. B. the inflation rate minus the nominal rate. C. the nominal rate times the inflation rate. D. the inflation rate divided by the nominal rate. E. the nominal rate plus the inflation rate.

A. The actual relationship is (1 + real rate) = (1 + nominal rate)/(1 + inflation rate). This can be approximated by the equation: Real rate = nominal rate inflation rate.

The ____________ refers to the potential conflict between management and shareholders. A. agency problem B. diversification problem C. liquidity problem D. solvency problem E. regulatory problem

A. The agency problem describes potential conflict between management and shareholders. The other problems are those of firm management only.

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%

A. The hurdle rate should be the required return from CAPM or (R = 4% + 1.4(11%-4%) = 13.8%.

The individual investor's optimal portfolio is designated by A. the point of tangency with the indifference curve and the capital allocation line. B. the point of highest reward to variability ratio in the opportunity set. C. the point of tangency with the opportunity set and the capital allocation line. D. the point of the highest reward to variability ratio in the indifference curve. E. None of the options are correct.

A. The indifference curve represents what is acceptable to the investor; the capital allocation line represents what is available in the market. The point of tangency represents where the investor can obtain the greatest utility from what is available.

The put/call ratio is computed as ____________, and higher values are considered ____________ signals. A. the number of outstanding put options divided by outstanding call options; bullish or bearish B. the number of outstanding put options divided by outstanding call options; bullish C. the number of outstanding put options divided by outstanding call options; bearish D. the number of outstanding call options divided by outstanding put options; bullish E. the number of outstanding call options divided by outstanding put options; bearish

A. The put/call ratio is computed as the number of outstanding put options divided by outstanding call options, and higher values are considered bullish or bearish signals.

Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the stdv of your portfolio was 0.18 and stdvM was 0.24, the beta of the portfolio would be approximately: A. 0.75 B. 0.56 C. 0.07 D. 1.03

A. s^2p / s^2m = b^2; (0.18)^2/(0.24)^2 = 0.5625; b = 0.75.

If a firm's sales decrease by 15%, and profits decrease by 20% during a recession, the firm's operating leverage is A. 1.33. B. 0.75. C. 5. D. −5.

A. −20/−15 = 1.33

Investors want high plowback ratios A. for all firms. B. whenever ROE > k. C. whenever k > ROE. D. only when they are in low tax brackets. E. whenever bank interest rates are high.

B.

Portfolio theory as described by Markowitz is most concerned with: The elimination of systematic risk. The effect of diversification on portfolio risk. The identification of unsystematic risk. Active portfolio management to enhance return.

B.

Your professor finds a stock-trading rule that generates excess risk-adjusted returns. Instead of publishing the results, she keeps the trading rule to herself. This is most closely associated with ________. A. regret avoidance B. selection bias C. framing D. insider trading E. none of the above

B.

You purchased a share of stock for $68. One year later, you received $3.00 as a dividend and sold the share for $74.50. What was your holding-period return? A. 12.5% B. 14.0% C. 13.6% D. 11.8%

B. ($3.00 + $74.50 - $68.00)/$68.00 = 0.1397, or 14.0%.

A reward-to-volatility ratio is useful in A. measuring the standard deviation of returns. B. understanding how returns increase relative to risk increases. C. analyzing returns on variable-rate bonds. D. assessing the effects of inflation. E. None of the options are correct.

B. A reward-to-volatility ratio is useful in understanding how returns increase relative to risk increases.

You buy 300 shares of Qualitycorp for $30 per share and deposit initial margin of 50%. The next day, Qualitycorp's price drops to $25 per share. What is your actual margin? A. 50% B. 40% C. 33% D. 60% E. 25%

B. AM = [300 ($25) - 0.5(300) ($30)]/[300 ($25)] = 0.40. (Price x Shares - margin)/(Price x Shares)

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.

B. AR = 14% - (5% + 1.0 (6%)) = +3.0%. A positive abnormal return suggests that there was firm-specific good news.

A 10% coupon bond maturing in 10 years that requires annual payments is expected to make all coupon payments but to pay only 50% of par value at maturity. What is the expected yield on this bond if the bond is purchased for $975? A. 10.00% B. 6.68% C. 11.00% D. 8.68% E. None of the options are correct.

B. FV = 500, PMT = 100, n = 10, PV = 975, i = 6.68%.

Portfolio theory as described by Markowitz is most concerned with A. the elimination of systematic risk. B. the effect of diversification on portfolio risk. C. the identification of unsystematic risk. D. active portfolio management to enhance returns.

B. Markowitz was concerned with reducing portfolio risk by combining risky securities with differing return patterns.

The measure of risk in a Markowitz efficient frontier is A. specific risk. B. standard deviation of returns. C. reinvestment risk. D. beta.

B. Markowitz was interested in eliminating diversifiable risk (and thus lessening total risk) and thus was interested in decreasing the standard deviation of the returns of the portfolio.

Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of 5%, what is the slope of the best feasible CAL? A. 0.64 B. 0.27 C. 0.08 D. 0.33 E. 0.36

B. Slope = (12 - 5)/26 = 0.2692

The holding-period return (HPR) on a share of stock is equal to A. the capital gain yield during the period plus the inflation rate. B. the capital gain yield during the period plus the dividend yield. C. the current yield plus the dividend yield. D. the dividend yield plus the risk premium. E. the change in stock price.

B. The HPR of any investment is the sum of the capital gain and the cash flow over the period, which for common stock is B.

The most common measure of loss associated with extremely negative returns is A. lower partial standard deviation. B. value at risk (VaR). C. expected shortfall. D. standard deviation.

B. The most common measure of loss associated with extremely negative returns is value at risk.

The unsystematic risk of a specific security A. is likely to be higher in an increasing market. B. results from factors unique to the firm. C. depends on market volatility. D. cannot be diversified away.

B. Unsystematic (or diversifiable or firm-specific) risk refers to factors unique to the firm. Such risk may be diversified away; however, market risk will rem. ain.

The risk-free rate is 7%. The expected market rate of return is 15%. If you expect a stock with a beta of 1.3 to offer a rate of return of 12% 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 is is underpriced D. buy the stock because it is underpriced E. None of the options, as the stock is fairly priced

B. sell short the stock because it is overpriced

Music Doctors just announced yesterday that its 1st quarter sales were 35% higher than last year's 1st quarter. You observe that Music Doctors had an abnormal return of -2% yesterday. This suggests that A) the market is not efficient. B) Music Doctors stock will probably rise in value tomorrow. C) investors expected the sales increase to be larger than what was actually announced. D) investors expected the sales increase to be smaller than what was actually announced. E) earnings are expected to decrease next quarter.

C.

Which statement about portfolio diversification is correct? a. Proper diversification can reduce or eliminate systematic risk. b. Diversification reduces the portfolio's expected return because it reduces a portfolio's total risk. c. As more securities are added to a portfolio, total risk typically can be expected to fall at a decreasing rate. The risk-reducing benefits of diversification do not occur meaningfully until at least 30 individual securities are included in the portfolio.

C.

Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor and portfolio B has a beta of 2.0 on the factor. The expected returns on portfolios A and B are 11% and 17%, respectively. Assume that the risk-free rate is 6% and that arbitrage opportunities exist. Suppose you invested $100,000 in the riskfree asset, $100,000 in portfolio B, and sold short $200,000 of portfolio A. Your expected profit from this strategy would be ______________. A. -$1,000 B. $0 C. $1,000 D. $2,000 E. none of the above.

C. $100,000(0.06) = $6,000 (risk-free position); $100,000(0.17) = $17,000 (portfolio B); -$200,000(0.11) = -$22,000 (short position, portfolio A); 1,000 profit.

An analyst has determined that the intrinsic value of HPQ stock is $20 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of HPQ in the coming year is A. $3.63. B. $4.44. C. $0.80. D. $22.50.

C. $20(1/25) = $0.80.

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 the data provided

C. 11% = 5% + 1.5(9% - 5%) = 11.0%; therefore, the security is fairly priced.

Light Construction Machinery Company has an expected ROE of 11%. The dividend growth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends. A. 3.0% B. 4.8% C. 8.25% D. 9.0%

C. 11% × 0.75 = 8.25%.

Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in portfolio _________. A. A;A B. A;B C. B;A D. B;B

C. 13% = 10% + 0.2F; F = 15%; B: 15% = 10% + 0.4F; F = 12.5%; therefore, short B and take a long position in A

Think Tank Company has an expected ROE of 26%. The dividend growth rate will be _______ if the firm follows a policy of plowing back 90% of earnings. A. 2.6% B. 10% C. 23.4% D. 90%

C. 26% × 0.90 = 23.4%.

Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and factor 2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________ if no arbitrage opportunities exist. A. 13.5% B. 15.0% C. 16.5% D. 23.0%

C. 7% + 0.75(1%) + 1.25(7%) = 16.5%.

Which of the following are mechanisms that have evolved to mitigate potential agency problems? I) Using the firm's stock options for compensation II) Hiring bickering family members as corporate spies III) Boards of directors forcing out underperforming management IV) Security analysts monitoring the firm closely V) Takeover threats A. II and V B. I, III, and IV C. I, III, IV, and V D. III, IV, and V E. I, III, and V

C. All the options except hiring bickering family members as corporate spies have been used to try to limit agency problems

Given the yield on a 3-year zero-coupon bond is 7% and forward rates of 6% in year 1 and 6.5% in year 2, what must be the forward rate in year 3? A. 7.2% B. 8.6% C. 8.5% D. 6.9%

C. f3 = (1.07)3/[(1.06) (1.065)] 1 = 8.5%

In the consolidation stage of the industry life cycle, A. it is difficult to predict which firms will succeed and which firms will fail. B. industry growth is very rapid. C. the performance of firms will more closely track the performance of the overall industry. D. it is difficult to predict which firms will succeed and which firms will fail, and industry growth is very rapid. E. industry growth is very rapid, and the performance of firms will more closely track the performance of the overall industry.

C. In the consolidation stage of the industry life cycle, the performance of firms will more closely track the performance of the overall industry.

Which of the following is not a source of systematic risk? A. The business cycle B. Interest rates C. Personnel changes D. The inflation rate E. Exchange rates

C. Personnel changes are a firm-specific event that is a component of nonsystematic risk. The others are all sources of systematic risk.

Assume you sell short 100 shares of common stock at $45 per share, with initial margin at 50%. What would be your rate of return if you repurchase the stock at $40 per share? The stock paid no dividends during the period, and you did not remove any money from the account before making the offsetting transaction. A. 20.03% B. 25.67% C. 22.22% D. 77.46%

C. Profit on stock = ($45 - $40) × 100 = $500, $500/$2,250 (initial investment) = 22.22%.

Which of the following statements is(are) true? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A. I only B. II only C. I and II only D. II and III only E. II, III, and IV only

C. Risk-averse investors consider a risky investment only if the investment offers a risk premium. Risk-neutral investors look only at expected returns when making an investment decision.

Which of the following statements regarding risk-averse investors is true? A. They only care about the rate of return. B. They accept investments that are fair games. C. They only accept risky investments that offer risk premiums over the risk-free rate. D. They are willing to accept lower returns and high risk. E. They only care about the rate of return, and they accept investments that are fair games

C. Risk-averse investors only accept risky investments that offer risk premiums over the risk-free rate.

Which of the following factors would not be expected to affect the nominal interest rate? A. The supply of loans B. The demand for loans C. The coupon rate on previously issued government bonds D. The expected rate of inflation E. Government spending and borrowing

C. The nominal interest rate is affected by supply, demand, government actions, and inflation. Coupon rates on previously issued government bonds reflect historical interest rates but should not affect the current level of interest rates.

High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be A. $1.00. B. $2.50. C. $2.69. D. $2.81. E. None of the options are correct.

C. g = .125 × .6 = 7.5%; $2.50(1.075) = $2.69.

A bond will sell at a discount when A. the coupon rate is greater than the current yield, and the current yield is greater than yield to maturity. B. the coupon rate is greater than yield to maturity. C. the coupon rate is less than the current yield, and the current yield is greater than the yield to maturity. D. the coupon rate is less than the current yield, and the current yield is less than yield to maturity. E. None of the options are true.

D.

Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 150 stocks in order to construct a mean-variance efficient portfolio constrained by 150 investments. They will need to calculate ___________ covariance. A. 12 B. 150 C. 22,500 D. 11,175

D.

Consider two bonds, F and G. Both bonds presently are selling at their par value of $1,000. Each pays interest of $90 annually. Bond F will mature in 15 years while bond G will mature in 26 years. If the yields to maturity on the two bonds change from 9% to 10%, A. both bonds will increase in value, but bond F will increase more than bond G. B. both bonds will increase in value, but bond G will increase more than bond F. C. both bonds will decrease in value, but bond F will decrease more than bond G. D. both bonds will decrease in value, but bond G will decrease more than bond F. E. None of the options are correct.

D.

Kahneman and Tversky (1973) reported that people give __________ weight to recent experience compared to prior beliefs when making forecasts. This is referred to as ____________. A. too little; hyper rationality B. too little; conservatism C. too much; framing D. too much; memory bias

D.

Music Doctors just announced yesterday that its 1st quarter sales were 35% higher than last year's 1st quarter. You observe that Music Doctors had an abnormal return of 2% yesterday. This suggests that A) the market is not efficient. B) Music Doctors stock will probably rise in value tomorrow. C) investors expected the sales increase to be larger than what was actually announced. D) investors expected the sales increase to be smaller than what was actually announced. E) earnings are expected to decrease next quarter.

D.

Subordination clauses in bond indentures A. may restrict the amount of additional borrowing the firm can undertake. B. are always bad for investors. C. provide higher priority to senior creditors in the event of bankruptcy. D. may restrict the amount of additional borrowing the firm can undertake and provide higher priority to senior creditors in the event of bankruptcy. E. All of the options are true.

D.

Suppose you forecast that the market index will earn a return of 15% in the coming year. Treasury bills are yielding 6%. The unadjusted beta of Mobil is 1.30. A reasonable forecast of the return on Mobil stock for the coming year is ___________ if you use a common method to derive adjusted betas. A. 15.0% B. 15.5% C. 16.0% D. 16.8%

D.

The Gordon model A. is a generalization of the perpetuity formula to cover the case of a growing perpetuity. B. is valid only when g is less than k. C. is valid only when k is less than g. D. is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when g is less than k. E. is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when k is less than g.

D.

The measure of risk for a security held in a diversified portfolio is: a. Specific risk. b. Standard deviation of returns. c. Reinvestment risk. d. Covariance.

D.

The risk that can be diversified away in a portfolio is referred to as ___________. I) diversifiable risk II) unique risk III) systematic risk IV) firm-specific risk A. I, III, and IV B. II, III, and IV C. III and IV D. I, II, and IV E. I, II, III, and IV

D.

Which of the following would be a viable way to earn abnormally high trading profits if markets are semistrong-form efficient? a. Buy shares in companies with low P/E ratios. b. Buy shares in companies with recent above-average price changes. c. Buy shares in companies with recent below-average price changes. d. Buy shares in companies for which you have advance knowledge of an improvement in the management team.

D.

Suppose that the average P/E multiple in the oil industry is 16. Shell Oil is expected to have an EPS of $4.50 in the coming year. The intrinsic value of Shell Oil stock should be A. $28.12. B. $35.55. C. $63.00. D. $72.00. E. None of the options are correct.

D. 16 × $4.50 = $72.00.

You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. 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 0.09? A. 85% and 15% B. 75% and 25% C. 67% and 33% D. 57% and 43% E. Cannot be determined.

D. 9% = w1(12%) + (1 - w1)(5%); 9% = 12%w1 + 5% - 5%w1; 4% = 7%w1; w1 = 0.57; 1 - w1 =0.43; 0.57(12%) + 0.43(5%) = 8.99%.

According to Michael Porter, there are five determinants of competition. An example of _____ is when a buyer purchases a large fraction of an industry's output and can demand price concessions. A. threat of entry B. rivalry between existing competitors C. pressure from substitute products D. bargaining power of buyers E. bargaining power of suppliers

D. According to Michael Porter, there are five determinants of competition. An example of bargaining power of buyers is when a buyer purchases a large fraction of an industry's output and can demand price concessions.

Suppose that Chicken Express, InC. has an ROA of 7% and pays a 6% coupon on its debt. Chicken Express has a capital structure that is 70% equity and 30% debt. Relative to a firm that is 100% equity-financed, Chicken Express's net profit will be ________, and its ROE will be ________. A. lower; lower B. higher; higher C. higher; lower D. lower; higher E. It is impossible to predict.

D. Chicken Express's net profit will be lower because it has to pay interest expense. But as long as Chicken Express's ROA exceeds the cost of its debt, leverage will have a positive impact on its ROE.

Security X has expected return of 12% and standard deviation of 18%. Security Y has expected return of 15% and standard deviation of 26%. 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. 0.033 E. 0.054

D. Cov(r X, r Y) = (0.7)(0.18)(0.26) = 0.0327

Which statement about portfolio diversification is correct? A. Proper diversification can eliminate systematic risk. B. The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities have been purchased. C. Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return. D. Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate. E. None of the statements are correct.

D. Diversification can eliminate only nonsystematic risk; relatively few securities are required to reduce this risk, thus diminishing returns result quickly.

An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.13 and a variance of 0.03 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.114; 0.128 B. 0.087; 0.063 C. 0.295; 0.125 D. 0.081; 0.052

D. E(r P) = 0.3(13%) + 0.7(6%) = 8.1%; SD of the Portfolio = 0.3(0.03)1/2 = 5.19%.

An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.114; 0.12 B. 0.087; 0.06 C. 0.295; 0.06 D. 0.087; 0.12 E. None of the options are correct.

D. E(r P) = 0.3(15%) + 0.7(6%) = 8.7%; SD of the Portfolio = 0.3(0.04)^1/2 = 6%.

The risk premium for common stocks A. cannot be zero, for investors would be unwilling to invest in common stocks. B. must always be positive, in theory. C. is negative, as common stocks are risky. D. cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in theory. E. cannot be zero, for investors would be unwilling to invest in common stocks and is negative, as common stocks are risky.

D. If the risk premium for common stocks were zero or negative, investors would be unwilling to accept the lower returns for the increased risk.

In the start-up stage of the industry life cycle, A. it is difficult to predict which firms will succeed and which firms will fail. B. industry growth is very rapid. C. firms pay a high level of dividends. D. it is difficult to predict which firms will succeed and which firms will fail, and industry growth is very rapid. E. industry growth is very rapid, and firms pay a high level of dividends.

D. In the start-up stage, it is very difficult to predict which firms will succeed and which firms will fail, as no historical data are available. In this stage, industry growth is very rapid (if the industry is successful) and firms pay little or no dividends.

Supply-side economists wishing to stimulate the economy are most likely to recommend A. a decrease in the money supply. B. a decrease in production output. C. an increase in the real interest rate. D. a decrease in the tax rate. E. an increase in mortgage rates.

D. Supply-siders argue that lowering tax rates stimulates investment.

For a two-stock portfolio, what would be the preferred correlation coefficient between the two stocks? A. +1.00 B. +0.50 C. 0.00 D. -1.00 E. None of the options are correct.

D. The correlation coefficient of -1.00 provides the greatest diversification benefits.

For a taxpayer in the 15% marginal tax bracket, a 15-year municipal bond currently yielding 6.2% would offer an equivalent taxable yield of A. 6.2%. B. 5.27%. C. 8.32%. D. 7.29%.

D. The equivalent taxable yield is: r = rm /(1 - t) OR , r x (1 - t)= rm D. 0.062 = r(1 - t); r = 0.062/(0.85); r = 0.0729 = 7.29%.

The global minimum variance portfolio formed from two risky securities will be riskless when the correlation coefficient between the two securities is A. 0.0. B. 1.0. C. 0.5. D. -1.0. E. any negative number.

D. The global minimum variance portfolio will have a standard deviation of zero whenever the two securities are perfectly negatively correlated.

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.

D. The more risk averse the investor, the less risk that is tolerated for a given rate of return

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. B. borrow some money at the risk-free rate and invest in the optimal risky portfolio. C. invest only in risky securities. D. borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities

D. The only way that an investor can create a portfolio that lies 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.

Which of the following determine(s) the level of real interest rates? I) The supply of savings by households and business firms II) The demand for investment funds III) The government's net supply and/or demand for funds A. I only B. II only C. I and II only D. I, II, and III

D. The value of savings by households is the major supply of funds; the demand for investment funds is a portion of the total demand for funds; the government's position can be one of either net supplier or net demander of funds. The above factors constitute the total supply and demand for funds, which determine real interest rates

Over the past year, you earned a nominal rate of interest of 10% on your money. The inflation rate was 5% over the same period. The exact actual growth rate of your purchasing power was A. 15.5%. B. 10.0%. C. 5.0%. D. 4.8%. E. 15.0%.

D. r = (1 + R)/(1 + I) -1; 1.10%/1.05% - 1 = 4.8%.

According to the index model, covariance among security pairs are: A. Due to the influence of a single common factor represented by the market index return. B. Extremely difficult to calculate C. Related to industry-specific events D. Usually positive E. Due to the influence of a single common factor represented by the market index return and usually positive.

E.

CDOs are divided in tranches A. that provide investors with securities with varying degrees of credit risk. B. and each tranch is given a different level of seniority in terms of its claims on the underlying pool. C. and none of the tranches is risky. D. and equity tranch is very low risk. E. that provide investors with securities with varying degrees of credit risk, and each tranch is given a different level of seniority in terms of its claims on the underlying pool.

E.

If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio's excess returns was 20%, the Sharpe measure would be A. 0.08. B. 0.03. C. 0.20. D. 0.11. E. 0.25.

E. (8 - 3)/20 = 0.25

You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $3.50 in dividends and $42 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return. A. $23.91 B. $24.11 C. $26.52 D. $27.50 E. None of the options are correct.

E. .10 = (42 - P + 3.50)/P; .10P = 42 - P + 3.50; 1.1P = 45.50; P = 41.36.

Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of __________. A. .0.67 B. 1.00 C. 1.30 D. 1.69 E. 0.75

E. 15% = 6% + bF; B: 8% = 6% + 1.0F; F = 12%; thus, beta of A = 9/12 = 0.75

A statistic that measures how the returns of two risky assets move together is: A. variance. B. standard deviation. C. covariance. D. correlation. E. covariance and correlation.

E. Covariance measures whether security returns move together or in opposition; however, only the sign, not the magnitude, of covariance may be interpreted. Correlation, which is covariance standardized by the product of the standard deviations of the two securities, may assume values only between +1 and 1; thus, both the sign and the magnitude may be interpreted regarding the movement of one security's return relative to that of another security.

Stingy Corporation is expected have EBIT of $1.2M this year. Stingy Corporation is in the 30% tax bracket, will report $133,000 in depreciation, will make $76,000 in capital expenditures, and will have a $24,000 increase in net working capital this year. What is Stingy's FCFF? A. 1,139,000 B. 1,200,000 C. 1,025,000 D. 921,000 E. 873,000

E. FCFF = EBIT(1 - T) + depreciation capital expenditures increase in NWC or 1,200,000(.7) + 133,000 76,000 24,000 = 873,000.

In the decline stage of the industry life cycle, A. the product may have reached obsolescence. B. the industry will grow at a rate less than the overall economy. C. the industry may experience negative growth. D. the product may have reached obsolescence, and the industry will grow at a rate less than the overall economy. E. the product may have reached obsolescence, the industry will grow at a rate less than the overall economy, and the industry may experience negative growth.

E. In the decline stage of the industry life cycle, the product may have reached obsolescence, the industry will grow at a rate less than the overall economy, and the industry may experience negative growth.

In the maturity stage of the industry life cycle, A. the product has reached full potential. B. profit margins are narrower. C. producers are forced to compete on price to a greater extent. D. the product has reached full potential and profit margins are narrower. E. the product has reached full potential, profit margins are narrower, and producers are forced to compete on price to a greater extent.

E. In the maturity stage of the industry life cycle, the product has reached full potential, profit margins are narrower, and producers are forced to compete on price to a greater extent.

One year ago, you purchased a newly-issued TIPS bond that has a 5% coupon rate, five years to maturity, and a par value of $1,000. The average inflation rate over the year was 3.2%. What is the amount of the coupon payment you will receive, and what is the current face value of the bond? A. $50.00, $1,000 B. $32.00, $1,032 C. $50.00, $1,032 D. $32.00, $1,050 E. $51.60, $1,032

E. The bond price, which is indexed to the inflation rate, becomes $1,000 × 1.032 = $1,032. The interest payment is based on the coupon rate and the new face value. The interest amount equals $1,032 × .05 = $51.60.

WACC is the most appropriate discount rate to use when applying a ______ valuation model.

FCFF