Financial MGMT FI361 Test 4 review

An efficient capital market is best defined as a market in which security prices reflect which one of the following? Select one: a. Current inflation b. All available information c. The historical arithmetic rate of return d. The historical geometric rate of return e. A risk premium

All Available Information

Which one of the following is defined as the average compound return earned per year over a multiyear period? Select one: a. Arithmetic average return b. Geometric average return c. Normal distribution of returns d. Variance of returns e. Standard deviation of returns

Geometric average return

Which one of the following will decrease the aftertax cost of debt for a firm? Select one: a. Decrease in the firm's beta b. Increase in tax rates c. Increase in the risk-free rate of return d. Decrease in the market price of the debt e. Increase in a bond's yield to maturity

Increase in tax rates

Which one of the following will increase the cost of equity, all else held constant? Select one: a. Decrease in future dividends b. Decrease in beta c. Increase in the dividend growth rate d. Increase in stock price e. Decrease in market risk premium

Increase in the dividend growth rate

Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital? Select one: a. Increase in the market value of the firm's common stock b. Increase in the firm's beta c. Decrease in a firm's tax rate d. Decrease in the book value of a firm's equity e. Increase in the market risk premium

Increase in the market value of the firm's common stock

Unsystematic risk can be defined by all of the following except: Select one: a. asset-specific risk. b. unique risk. c. diversifiable risk. d. market risk. e. unrewarded risk.

Market Risk

You own a portfolio that is invested as follows: $13,700 of Stock A, $4,800 of Stock B, $16,200 of Stock C, and $9,100 of Stock D. What is the portfolio weight of Stock B?

total value=(13700+4800+16200+9100) =$43800. hence weight of B =(4800/43800)=10.96%

The standard deviation measures the _____ of a security's returns over time.

volatility

Healthy Snacks has a target capital structure of 60 percent common stock, 3 percent preferred stock, and 37 percent debt. Its cost of equity is 16.8 percent, the cost of preferred stock is 11.4 percent, and the pretax cost of debt is 8.3 percent. What is the company's WACC if the applicable tax rate is 34 percent?

12.45%

You own a stock with an average return of 14.6 percent and a standard deviation of 21.2 percent. In any one given year, you have a 95 percent chance that you will not lose more than _____ percent nor earn more than ____ percent on this stock.

95 percent probability range =0.146-(2*0.212) Not lose more than =0.146-(2*0.212)= -27.80% Not earn more than =0.146+(2*0.212)= 57.00%

The weighted average cost of capital is defined as the weighted average of a firm's

cost of equity, cost of preferred, and its aftertax cost of debt.

You've observed the following returns on Blast It Corporation's stock over the past five years: 19 percent, -23 percent, 31 percent, 18 percent, and -7 percent, respectively. What was the variance of the returns over this period?

=(0.19 + -0.21 + 0.31 + 0.18 + -0.07)/5 =0.08 =(1/4) * ( ((0.19-0.08)^2) + ((-0.23-0.08)^2) + ((0.31-0.08)^2) + ((0.18-0.08)^2) + ((-0.07-0.08)^2) ) =0.0484

A stock has an expected return of 14.3 percent, the risk-free rate is 3.9 percent, and the market risk premium is 7.8 percent. What must the beta of this stock be?

As per CAPM, Expected return= Rf+Rp*Beta 14.3= 3.9+7.8*Beta Beta= 14.3-3.9/7.8 Beta= 10.4/7.8 = 1.33

Suppose a stock had an initial price of $36 per share, paid a dividend of $.42 per share during the year, and had an ending share price of $34. What was the capital gains yield?

Capital gains yield = [($34 / $36) - 1] * 100% = - 5.56%

Traditional Bank has an issue of preferred stock with an annual dividend of $7.50 that just sold for $62 a share. What is the bank's cost of preferred stock?

Cost of PS = Div/Price =7.50/62 =0.120968 =12.10%

Tim's Tools just issued a dividend of $2.22 per share on its common stock. The company is expected to maintain a constant 2.8 percent growth rate in its dividends indefinitely. If the stock sells for $19 a share, what is the company's cost of equity?

Cost of equity=(D1/P0)+g D1=dividend payable next year =(2.22*102.8%) =$2.28216 P0=current market price g=growth rate cost=(2.28216/19)+0.028 =0.1481 =14.81%

Bermuda Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of .45. The cost of equity is 17.6 percent and the pretax cost of debt is 8.9 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 35 percent?

Debt Equity ratio = Debt / Equity = 0.45 If Equity is 1 debt is 0.45. Total of debt + Equity = 0.45 + 1 = 1.45 Capital structure weight of the firm's equity = Equity / Total debt plus equity = 1 / 1.45 = 68.97%

Which term best refers to the practice of investing in a variety of diverse assets as a means of reducing risk?

Diversification

You own a portfolio that is invested 43 percent in Stock A, 16 percent in Stock B, and the remainder in Stock C. The expected returns on stocks A, B, and C are 9.1 percent, 16.7 percent, and 11.4 percent, respectively. What is the expected return on the portfolio?

Expected return on portfolio = 0.43 x 9.10 + 0.16 x 16.70 + 0.41 x 11.40 = 11.26%

A stock has a beta of 1.32, the expected return on the market is 12.72, and the risk-free rate is 4.05. What must the expected return on this stock be?

Expected return= Rf+B(Rm-Rf) Rf= 4.05% B= 1.32 Rm= 12.72 Exp Return= 4.05+1.32(12.72-4.05) =15.49%

Assume large-company stocks returned 12.1 percent on average over the past 88 years. The risk premium on these stocks was 8.6 percent and the inflation rate was 3.0 percent. What was the average nominal risk-free rate of return for those 88 years?

Nominal risk-free rate = 12.1% -8.6% = 3.5%

Which one of the following is defined as a bell-shaped frequency distribution that is defined by its average and its standard deviation?

Normal Distribution

Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent?

Portfolio weight

On a particular risky investment, investors require an excess return of 7 percent in addition to the risk-free rate of 4 percent. What is this excess return called?

Risk Premium

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? Select one: a. Amount of debt used to finance the project b. Length of the project's life c. Mix of funds used to finance the project d. Risk level of the project e. Use, or lack, of preferred stock as a financing option

Risk level of the project

You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.86 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?

Setting up the equation for the beta of our portfolio, we get: bp = 1.0 = 1/3(0) + 1/3(1.86) + 1/3(bX) Solving for the beta of Stock X, we get: bX = 1.14

Over the period of 1926-2014, which one of the following investment classes had the highest volatility of returns?

Small-company stocks

Farm Equipment announced this morning that its next annual dividend will be decreased to $1.67 a share and that all future dividends will be decreased by an additional 1.3 percent annually. What is the current value per share if the required return is 15.7 percent?

Stock Price = D1/(Ke-g) =1.67/(0.157+0.013) =9.82

The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is measured by the:

beta coefficient.

A portfolio is:

a group of assets held by an investor.