FINA 320 Exam 5
The primary purpose of portfolio diversification is to: A. increase returns and risks. B. eliminate all risks. C. minimize idiosyncratic risk. D. minimize systematic risk. E. lower both returns and risks.
C. minimize idiosyncratic risk.
Which of the following would likely have the greatest amount of systematic risk? a A portfolio of the common stocks of 100 randomly-selected companies. b. The market portfolio. C. A portfolio half invested in the market portfolio and half invested in Treasury bills. D. A portfolio half invested in the market portfolio and half invested in stocks with betas = 1.50.
D. A portfolio half invested in the market portfolio and half invested in stocks with betas = 1.50
Which of the following would likely have the greatest amount of systematic risk? A. A portfolio of the common stocks of 100 randomly-selected companies B. The market portfolio c. A portfolio half invested in the market portfolio and half invested in Treasury bills. D. A portfolio half invested in the market portfolio and half invested in stocks with betas = 1.50. E. None of the above
D. A portfolio half invested in the market portfolio and half invested in stocks with betas = 1.50.
A stock investor owns a diversified portfolio of 15 stocks. What will be the likely effect on portfolio return standard deviation from adding one more stock? A. A slight increase will occur. B. Alarge increase will occur. C. Alarge decrease will occur. D. A slight decrease will occur. E. none of the above
D. A slight decrease will occur.
Which of the following would be considered an example of systematic risk? A. Intel reports record sales B. Quarterly profit for GM equals expectations. c. Lower quarterly sales for IBM than expected. D. Greater unemployment rate than expected. E. None of the above
D. Greater unemployment rate than expected.
Which one of the following statements related to risk is correct? A The beta of a portfolio must increase when a stock with a high return standard deviation is added to the portfolio. B. Every portfolio that contains 25 or more securities is free of unsystematic risk. Adding five additional stocks to a diversified portfolio must lower the portfolio's beta. D. Portfolio beta can be effectively lowered by adding T-bills to the portfolio. E. None of the above
D. Portfolio beta can be effectively lowered by adding T-bills to the portfolio.
Which one of the following statements related to risk is correct? A. The beta of a portfolio must increase when a stock with a high return standard deviation is added to the portfolio. B. Every portfolio that contains 25 or more securities is free of unsystematic risk. C. Adding five additional stocks to a diversified portfolio must lower the portfolio's beta. D. Portfolio beta can be effectively lowered by adding T-bills to the portfolio. F None of the above
D. Portfolio beta can be effectively lowered by adding T-bills to the portfolio.
The principle of diversification tells us that: A. Concentrating an investment in two or three large stocks will eliminate all of your risk. B. Spreading an investment across many diverse assets cannot (in an efficient market) eliminate any risk. C. Spreading an investment across many diverse assets will eliminate all of risk. D. Spreading an investment across many diverse assets will eliminate some of the risk. E. None of the above.
D. Spreading an investment across many diverse assets will eliminate some of the risk.
Which of the following statements is more likely to be correct concerning the statement, "Stock A has a higher expected return than stock B"? A Stock A has more non-systematic risk. Stock B plots below the security market line. c. Stock B is a cyclical stock. D. Stock A has a higher beta. E. None of the above
D. Stock A has a higher beta.
If the market portfolio is expected to offer returns of 16%, then what can be said about a portfolio expected to return 13%? A It plots below the security market line. B. Part of the portfolio is invested in Treasury bills. c. The portfolio is not diversified. D. The portfolio's beta is less than 1.0. E. None of the above
D. The portfolio's beta is less than 1.0.
Which of the following portfolios might be expected to exhibit less unsystematic risk? A. Five random stocks; portfolio beta = .8 B. Three random stocks; portfolio beta = 1.2 c. Ten random stocks; portfolio beta = 1.0 us D. Thirty random stocks; portfolio beta unknown E. Not enough information to answer this question
D. Thirty random stocks; portfolio beta unknown
At a recent Haggerty Semiconductors Board of Directors meeting, Merle Haggerty was asked to discuss the topic of the company's weighted average cost of capital (WACC). At the meeting Haggerty made the following statements about the company's WACC: Statement 1: A company creates value by producing a higher return on its assets than the cost of financing those assets. As such, the WACC is the cost of financing a firm's assets and can be viewed as the firm's opportunity cost of financing its assets. Statement 2: Since a firm's WAC reflects thalaverage risk of the projects that make up the firm, it is not appropriate for evaluating all new projects. It should be adjusted upward for projects with greater-than-average risk and downward for projects with less-than-average risk. Are Statement 1 and Statement 2, as made by Haggerty CORRECT? A. Statement 1: correct; statement 2: correct B. Statement 1: incorrect; statement 2: correct c. Statement 1: correct; statement 2: incorrect D. Statement 1: incorrect; statement 2: incorrect E. None of the above
A. Statement 1: correct; statement 2: correct
The systematic risk of the market is measured by a: A, beta of 1. B. beta of 0. C. return standard deviation of 1. D. return standard deviation of O. E. None of hte above
A, beta of 1.
Assume that a company has equal amounts of debt, common stock, and preferred stock. An increase in the corporate tax rate of a firm will cause its weighted average cost of capital (WACC) to A, fall B rISe c. remain unchanged D. either fall or rise, depending on the riskiness of the company's debt E. None of the above
A, fall
All else the same, a higher corporate tax rate ________________ A, will decrease the WACC of a firm with some debt in its capital structure B, will increase the WACC of a firm with some debt in its capital structure c. will not affect the WACC of a firm with some debt in its capital structure D. will decrease the WACC of a firm with no debt in its capital structure E. None of the above
A, will decrease the WACC of a firm with some debt in its capital structure
Which one of the following indicates a portfolio is being effectively diversified? A. A decrease in the portfolio beta B. An increase in the portfolio rate of return C. An increase in the portfolio standard deviation D. A decrease in the portfolio standard deviation E. None of the above
A. A decrease in the portfolio beta
_________________refers to the way a company finances itself through some combination of loans, bond sales, preferred stock sales, common stock sales, and retention of earnings. A. Capital structure B. Cost of capital c. Working capital management D. NPV E. None of the above
A. Capital structure
Which of the following would decrease a portfolio's systematic risk? A. Common stock with upsitive beta is sold and replaced with Treasury bills. B. Stocks with a beta equal to the market portfolio beta are added to a portfolio of Treasury bills, C. Low-beta stocks are sold and replaced with high-beta stocks. D. A stock is sold in favor of a different stock with the same beta. E. The portfolio beta is less than one and the risk-free rate declines.
A. Common stock with upsitive beta is sold and replaced with Treasury bills.
What would you recommend to an investor who is considering an investment that, according to its beta, plots above the security market line (SML)? A. Invest; return is high relative to risk. B. Don't invest; risk is high relative to return. c. Don't invest; stocks revert to the SML over time. D. Invest; stocks above the SML have little non-systematic risk. E, none of the above
A. Invest; return is high relative to risk.
Which one of the following is least effective in reducing the unsystematic risk of a portfolio? A. Reducing the number of stocks held in a portfolio B. Adding bonds to a stock portfolio C. Adding international securities into a portfolio of U.S. stocks D. Adding U.S. Treasury bills to a risky portfolio E. Adding technology stocks to a portfolio of industrial stocks
A. Reducing the number of stocks held in a portfolio
Over the past 75 years, which of following investments has provided the largest average return? A. Small company stocks B. Common stocks c. Treasury bills D. Treasury bonds E. Corporate bonds
A. Small company stocks
In calculating the weighted average cost of capital (WACC), which of the following statements is least accurate? A. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding B. Different methods for estimating the cost of common equity might produce different results ‡ C.The cost of preferred equity capital is the preferred dividend divided by the price of preferred shares D. The weights used in calculating WACC are based on the market values of each capital components E None of the above
A. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding
In calculating the weighted average cost of capital (WACC), which of the following statements is least accurate? A. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding B. Different methods for estimating the cost of common equity might produce different results ‡ C. The cost of preferred equity capital is the preferred dividend divided by the price of preferred shares D. The weights used in calculating WAC are based on the market values of each capital components E. None of the above
A. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding
In calculating the weighted average cost of capital (WACC), which of the following statements is least accurate? A. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt B. Different methods for estimating the cost of common equity might produce different results= C. The cost of preferred equity capital is the preferred dividend divided by the price of preferred shares D. The weights used in calculating WACC are based on the market values of each capital components E. None of the above
A. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt
Which of the following statement about equity beta is true? A. The slope of the security market line measures a security's beta (non-diversifiable risk) and beta can change whenever there is a change in investors' expectations of inflation and/or their degree of risk aversion B. Although the beta of a diversified portfolio represents the risk which cannot be diversified away, the beta of a single security, since it is not diversified, is a measure of its total risk C. A security's beta measures its non-diversifiable (systematic, or market) risk relative to that of the market portfolio D. Beta measures systematic risk, but if a firm's stockholders are not well diversified, beta may not be accurate E. None of the statement above is true
A. The slope of the security market line measures a security's beta (non-diversifiable risk) and beta can change whenever there is a change in investors' expectations of inflation and/or their degree of risk aversion
The type of risk that we can diversify away is A. Unsystematic risk B. Systematic risk c. Nondiversifiable risk D. Market risk E. None of the above
A. Unsystematic risk
The return standard deviation of a portfolio: A. can be less than the return standard deviation of the least risky security in the portfolio. B. can never be less than the return standard deviation of the most risky security in the portfolio. C. must be equal to or greater than the lowest return standard deviation of any single security held in the portfolio D. is an arithmetic average of the return standard deviations of the individual securities which comprise the portfolio. E. None of the above
A. can be less than the return standard deviation of the least risky security in the portfolio.
The ________ the beta coefficient the ___________ the expected return, on average. A. higher; higher B. higher; lower C. lower; higher D lower; lower or higher (depending on the level of the risk-free rate) E. None of the above
A. higher; higher
The slope of an assets security market line is the A. market risk premium B. portfolio weight C. beta coefficient D. risk-free interest rate E. None of the above
A. market risk premium
The slope of an assets security market line is the _________ A. market risk premium B. portfolio weight c. beta coefficient D. risk-free interest rate E. None of the above
A. market risk premium
Regarding diversification _____________________ A. most of the benefits are realized with about 20 to 30 stocks B it is the process of increasing the riskiness associated with individual assets by spreading an investment across numerous assets C. the portfolio returns are reduced, and the standard deviation of that portfolio remains unchanged D. there is no limit to the amount of risk that can be eliminated through this process E. None of the above
A. most of the benefits are realized with about 20 to 30 stocks
Assume a firm uses a constant WACC to select investment projects rather than adjusting the projects for risk. If so, the firm will tend to: A. reject profitable, low-risk projects and accept unprofitable, high-risk projects B, accept profitable, low-risk projects and reject unprofitable, high-risk projects = C, accept profitable, low-risk projects and accept unprofitable, high-risk projects = D. accept profitable, high-risk project and reject unprofitable, low risk projects E. None of the above
A. reject profitable, low-risk projects and accept unprofitable, high-risk projects
The intercept point of the security market line is the rate of return which corresponds to: A. the risk-free rate R the market return C. a return of zero. D, the market risk premium E. None of the above
A. the risk-free rate
The variance of an investment's returns is a measure of the: A. volatility of the rates of return. B. probability of a negative return. C. historic return over long periods D. average value of the investment. E. none of the above
A. volatility of the rates of return.
All else the same, a higher corporate tax rate A. will decrease the WACC of a firm with some debt in its capital structure B. Will increase the WACC of a firm with some debt in its capital structure c. will not affect the WACC of a furm with some debt in its capital structure D. will decrease the WACC of a firm with no debt in its capital structure E. None of the above
A. will decrease the WACC of a firm with some debt in its capital structure
When calculating the weighted average cost of capital (WACC) an adjustment is made for taxes because: A. equity is risky B, the interest on debt is tax deductible C. company has to pay taxes on its taxable incomes D. investors suffer from double taxation problem E, none of the above
B, the interest on debt is tax deductible
Which of the following events will reduce a company's weighted average cost of capital (WACC)? A. A reduction in the company's bond rating B. A reduction in the market risk premium C. An increase in risk free rate D. A decrease in the company tax rate E None of the above
B. A reduction in the market risk premium
Which of the following risks would be classified as a non-systematic risk for an auto manufacturer? A. Interest rates B. Steel prices C Business cycles D. Foreign exchange rates E none of the above
B. Steel prices
Bud is an undiversified investor and is considering two alternative stocks for purchase. Stock A has a beta of 0.85 and stock B has a beta of 1.6. If Bud expects the stock market to boom next year (strong bull market), which stock should he purchase? A. Stock A B. Stock B C. The one with the highest return standard deviation D. It does not matter; both are equally good. E. The one with the most total risk.
B. Stock B
Holding everything else equal, which one of the following should earn the highest risk premium based on CAPM? A. A very well-diversified portfolio B. Stock with a beta of 1.38 C. Stock with a beta of .74 D. U.S. Treasury bill F Portfolio with a beta of 1.01
B. Stock with a beta of 1.38
Which of the following describes a stock that plots above the security market line? A. The price of the stock is too high B. The expected return of the stock is too high C. The stock's beta is too high D. The stock provides a return that is less than the average return on the market E. None of the above
B. The expected return of the stock is too high
What is the typical relationship between the return standard deviation of an individual common stock and the return standard deviation of a diversified portfolio of common stocks? A. The individual stock's return standard deviation is lower. B. The individual stock's return standard deviation is higher. C. The return standard deviations should be equal. D. There is no way to predict this relationship. E. None of the above
B. The individual stock's return standard deviation is higher.
Which one of the following risks is irrelevant to a well-diversified investor? A. Systematic risk B. Unsystematic risk C. Market risk D. Non-diversifiable risk E All risks above are relevant to a well-diversified investor.
B. Unsystematic risk
Which one of the following risks is irrelevant to a well-diversified investor? A. Systematic risk B. Unsystematic risk C. Market risk D. Non-diversifiable risk E. All risks above are relevant to a well-diversified investor.
B. Unsystematic risk
Holding all else equal, if the beta of a stock increases, the stock's price will: A Increase B. decrease c. remain unchanged D. increase or decrease E. none of the above
B. decrease
Suppose that the Federal Reserve takes actions that cause the risk-free rate to fall. All else the same (that is, the market risk premium and stock beta remain unchanged), we would expect a firm's cost of equity to A, increase if we are using the SML B. decrease if we are using the SML C. either increase or decrease if we are using the SML, but we can't determine which without more information increase if expected return on the market decreases E, decrease if the firm's beta increases
B. decrease if we are using the SML
Although non-systematic risk is present in differing amounts, individual stocks are: A. exposed to the same amount of systematic risk. B. exposed to differing amounts of systematic risk also. c. not exposed to systematic risk; only the general economy is subject to systemtic risk. D. able to diversify away their systematic risk. E. none of the above
B. exposed to differing amounts of systematic risk also.
The key to efficient diversification is to build a portfolio of securities that are: A. highly and positively correlated with one another B. less than perfectly correlated with one another. C. perfectly correlated with one another. D. in the same industry E. none of the above
B. less than perfectly correlated with one another.
The key to efficient diversification is to build a portfolio of securities that are: A. highly and positively correlated with one another B. less than perfectly correlated with one another. perfectly correlated with one another. D, in the same industry E, none of the above
B. less than perfectly correlated with one another. perfectly correlated with one another.
The expected rate of return on a stock portfolio is a weighted average of expected returns of each stock in the portiolio, where the weights are Based on the: A number of shares owned of each stock B. market price per share of each stock. C. market value of the investment in each stock. D. original amount invested in each stock E Cost per share or each stock held
C. market value of the investment in each stock.
If a stock portfolio is well diversified, then the portfolio return variance: A. will equal the return variance of the most volatile stock in the portfolio. B. may be less than the return variance of the least risky stock in the portfolio. c. must be equal to or greater than the return variance of the least risky stock in the portfolio D will be a weighted average of the return variances of the individual securities in the portfolio F will be an arithmetic average of the return variances of the individual securities in the portfolio.
B. may be less than the return variance of the least risky stock in the portfolio.
When firms develop a WACC for individual projects based on the cost of capital for other firms in similar lines of business as the project, the firm is utilizing a: A. subjective risk approach B. pure play approach divisional cost of capital approach D, capital adjustment approach E. None of the above
B. pure play approach
When calculating the weighted average cost of capital (WACC) an adjustment is made for taxes because: A. equity is risky B. the interest on debt is tax deductible c. company has to pay taxes on its taxable incomes D. investors suffer from double taxation problem E none of the above
B. the interest on debt is tax deductible
The company cost of capital (WACC) may be an inappropriate discount rate for a capital budgeting proposal if: A, it calculates a negative NPV for the proposal. B. the proposal has a different degree of risk. c, the company has unique risk. D. the company expects to earn more than the risk-free rate. E. WACC is an appropriate discount rate for all projects of the firm.
B. the proposal has a different degree of risk.
Which one of the following is the best example of a diversifiable risk? A. Interest rates increase B. Core inflation increases C. A firm's sales decrease D. Taxes decrease E. None of the above
C. A firm's sales decrease
The weighted average of betas of all individual assets is: A. exactly 0 B. between O and 1 C. Exactly 1 D. greater than 1 E. unknown; betas are continually changing.
C. Exactly 1
Which of the following is most directly affected by the level of systematic risk in a security? A. Variance of its returns B. Standard deviation of its returns C. Its expected rate of return D. Risk-free rate E. Market risk premium
C. Its expected rate of return
A firm that uses its WACC as a cutoff without consideration of project risk? A. Tends to become more risky over time B. Tends to eject more negative NPV projects over time C. Likely will see its WACC rise over time D. Will only accept projects where the IRR is equal to the WACC E. None of above
C. Likely will see its WACC rise over time
Which of the following is true regarding the WACC? A. The WACC is equal to the firm's embedded debt cost times (1- the tax rate). B The WACC can be estimated by taking the simple average of the cost of equity, cost of debt and cost of preferred stocks. C. The WACC is the required return on any investment a firm makes that has a level of risk equal to that of present operations D. The WACC reflects the risk and target capital structure of the market as a whole. E. None of the above
C. The WACC is the required return on any investment a firm makes that has a level of risk equal to that of present operations
Select the statement that is most correct A. An increase in the corporate tax rate, all other factors held constant, should lead to an increase in a firm's weighted average cost of capital (WACC) B. The WACC represents the historical cost of capital and is usually calculated on a before-tax basis C. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are tax deductible D. Even if project risks vary widely within a firm, a project's cash flows should always be discounted at the corporate cost of capital (WACC) E. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are tax deductible
C. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are tax deductible
Select the statement that is most correct A. An increase in the corporate tax rate, all other factors held constant, should lead to an increase in a firm's weighted average cost of capital (WACC). B. The WACC represents the historical cost of capital and is usually calculated on a before-tax basis C. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are tax deductible D. Even if project risks vary widely within a firm, a project's cash flows should always be discounted at the corporate cost of capital (WACC) E. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are tax deductible
C. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are tax deductible
By efficiently diversifying, an investor can: A, eliminate most risks. B. eliminate most systematic risk. C. eliminate most unsystematic risk D. eliminate no risk at all. E. none of the above.
C. eliminate most unsystematic risk
The expected return on a portfolio: I can never exceed the expected return of the best performing security in the portfolio. lI. can never be lower than the expected return of the worst performing security in the portfolio. Ill. is independent of the unsystematic risks of the individual securities held in the portfolio. IV. is independent of the allocation of the portfolio amongst individual securities. A. I and Ill only B. ll and IV only C. l, ll and Ill only D 1, Il, Ill, and IV E. None of thea above
C. l, ll and Ill only
The cost of debt capital for a firm A. is equal to the current yield (not YTM) on the firm's outstanding bonds B. can be calculated by estimating the beta of the firm's equity and then using the SMI c. can be calculated by looking at the coupon rates on existing bonds of similar risk D. can be estimated even if the firm's bonds are not publicly traded, by looking at the yield to maturity on bonds outstanding from peer group firms with similar ratings and maturity. E. None of the above
D. can be estimated even if the firm's bonds are not publicly traded, by looking at the yield to maturity on bonds outstanding from peer group firms with similar ratings and maturity.
stock's risk premium is equal to the: A expected market return times beta. B. Treasury bill yield plus expected market return. C. risk-free rate plus expected market risk premium. D. expected market risk premium times beta, E none of the above
D. expected market risk premium times beta,
Standard deviation is one of the most common measures of A, the normal distribution B. the inflation rate c. the risk premium D. return volatility E. None of the above
D. return volatility
A stock has been held for one year, during which time its dividend yield was greater than its capital gains yield. For this stock, the percentage return: A is zero. B. is negative. c. equals the dividend yield. d. less than dividend yield E cannot be determined
E cannot be determined
The major benefit of diversification is to: A. increase the expected return. B increase social benefit of the portfolio c. remove negative risk assets from the portfolio. D. reduce the portfolio's systematic risk. E reduce the expected risk.
E reduce the expected risk.
Which one of the following is an example of unsystematic risk? A. An across the board increase in income taxes B Adoption of a national sales tax C Decrease in the national level of inflation D. An increased feeling of global prosperity E. National decrease in consumer spending on entertainment
E) National decrease in consumer spending on entertainment
Which one of the following statements is correct concerning unsystematic risk? A. An investor is rewarded for assuming unsystematic risk. B. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk. C. Beta measures the level of unsystematic risk inherent in an individual security. D. Standard deviation is a measure of unsystematic risk. E. None of the above
E. None of the above
The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which one of the following statements is true given this information? A. The actual expected stock return will graph above the security market line. B. The stock is currently underpriced. C. To be correctly priced according to CAPM, the stock should have an expected return of 13.56 percent. D. The stock has less systematic risk than the overall market. E. The actual expected stock return indicates the stock is currently overpriced.
E. The actual expected stock return indicates the stock is currently overpriced. The actual is is 13.72, which is more than CAPM
The standard deviations of individual stocks are generally higher than the standard deviation of the market portfolio because individual stocks: A. offer higher returns. B. have more systematic risk. C. have more diversifiable risk. D. do not have unique risk. E. none of the above
E. none of the above
Which of the following is false regarding risk and return? A. The risk-free asset earns the lowest rate of return. B. The reward for bearing risk is known as the standard deviation. C. Based on historical data, there are rewards for bearing risk. D. An increase in the systematic risk of an investment will result in an increased risk premium. E. None of the above
b. The reward for bearing risk is known as the standard deviation.
Which of the following is false regarding risk and return? A. The risk-free asset earns the lowest expected rate of return. b. The reward for bearing risk is known as the standard deviation. C. Based on historical data, there are rewards for bearing risk. d An increase in the risk of an investment will result in an increased risk premium.
b. The reward for bearing risk is known as the standard deviation.
Most of the beneficial effects of diversification will have been received by the time a portfolio of common stocks contains A. 2 B 5 c. 25 D. 50 E None of the above
c. 25
Which of the following is false concerning diversification? Assume that the securities being considered for selection into a portfolio are not perfectly correlated. A. As more securities are added to the portfolio, the unsystematic risk of the portfolio declines. B. As more securities are added to the portfolio, the total risk of the portfolio declines c. As more securities are added to the portfolio, the systematic risk of the portfolio declines. D As more securities are added to the portfolio, the portfolio risk eventually approaches the level of systematic risk in the market. E. None of the above
c. As more securities are added to the portfolio, the systematic risk of the portfolio declines.
Which of the following choices best describes the role of taxes on the after-tax cost of capital in the U.S. from the different capital sources? A. Common equity: no effect; preferred equity: decrease; debt: decrease B Common equity: decrease; preferred equity: decrease; debt: no effect c. Common equity: no effect; preferred equity: no effect; debt: decrease D common equity: decrease; preferred equity: decrease; debt: decrease E. None of the above
c. Common equity: no effect; preferred equity: no effect; debt: decrease
What will happen to a stock that offers a lower risk premium than predicted by the CAPM? A. Its beta will increase B. Its beta will decrease c. Its price will decrease until the expected return is increased. D. Its price will increase until the expected return is reduced E. None of the above
c. Its price will decrease until the expected return is increased.
Hanson Aluminum, Inc. is considering whether to build a mill based around a new rolling technology the company has been developing. Management views this project as being riskier than the average project the company undertakes. Based on their analysis of the projected cash flows, management determines that the project's internal rate of return is equal to the company's cost of capital. If the project goes forward, the company will finance it with newly issued debt with an after-tax cost less than the project's IRR. Should management accept or reject this project? A. Accept, because the marginal cost of the new debt is less than the project's internal rate of return B. Accept, because the project returns the company's cost of capital. c. Reject, because the project reduces the value of the company when its risk is taken into account D. Reject, because its NPV is zero when evaluated at the firm's marginal cost of capital E. A decision cannot be made without additional information
c. Reject, because the project reduces the value of the company when its risk is taken into account
Stock A has a beta coefficient of 0.9, and stock B has a beta coefficient of 1.2. Which of the following statements is false regarding these two stocks? Selected A Stock A is less risky from the market's perspective than a typical stock, and stock B is more risky than a typical stock B. Stock B, if purchased, will increase the market risk of a portfolio more than stock A would (if purchased). c. Stock A necessarily must have a lower standard deviation of returns than stock B. D. Stock B must have a higher expected return than stock A if both of them are priced properly. E. None of the above
c. Stock A necessarily must have a lower standard deviation of returns than stock B.
The cost of preferred stock is equal to the preferred stock dividend: A. multiplied by the market price B. multiplied by the par value c. divided by the market price D. divided by its par value E. None of the above
c. divided by the market price
The expected rate of return on a stock portfolio is a weighted average of expected returns of each stock in the portfolio, where the weights are based on the A. number of shares owned of each stock. B. market price per share of each stock. c. market value of the investment in each stock. D. original amount invested in each stock E. cost per share of each stock held
c. market value of the investment in each stock.
If a security plots below the security market line, it is: A not rewarding the investor for its non-systematic risk. B underpriced, a situation that should be temporary. c. offering too little return to justify its risk. D a defensive security, which expects to offer lower returns E none of the above
c. offering too little return to justify its risk.
The relevant risk for the fair market pricing of financial securities is the A. standard deviation of the investment's return B total risk c. systematic risk D. non-systematic risk E. None of the above
c. systematic risk
A firm is considering an investment in a project whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should A. Increase the IRR of the asset to reflect the greater risk B. Increase the NPV of the asset to reflect the greater risk C. Reject the asset, since its acceptance would increase the firms risk D. Increase the cost of capital used to evaluate the project to reflect the project's higher risk. E. None of the above
d. Increase the cost of capital used to evaluate the project to reflect the project's higher risk.
