Smart book exam 4
An efficient market is one in which any change in available information will be reflected in the company's stock price ___.
immediately
Dividends are the ______ component of the total return from investing in a stock.
income
The expected return on the market will increase if the risk-free rate _________ or if the market risk premium _____
increases; increases
An efficient market is one that fully reflects all available ______.
information
Stock prices fluctuate from day to day because of _____.
information flow
The capital gains yield can be found by finding the difference between the ending stock price and the initial stock price and dividing it by the ______.
initial stock price
The WACC is the minimum return a company needs to earn to satisfy _____.
its bondholders its stockholders
The probability of an outcome being more than three standard deviations away from the mean in a normal distribution is approximately ___ percent.
less than 1
The most appropriate weights to use in the WACC are the ______ weights.
market value
Preferred stock ___.
pays a constant dividend pays dividends in perpetuity
Preferred stock ___.
pays a constant dividend pays dividends in perpetuity
The security market line (SML) shows that the relationship between a security's expected return and its beta is ______.
positive
eturns tell how much was received for each dollar invested, so they can be applied to any initial investment amount.
precent
returns tell how much was received for each dollar invested, so they can be applied to any initial investment amount.
precent
The rate used to discount project cash flows is known as the ___.
required return cost of capital discount rate
The Sharpe ratio measures ___.
reward to risk
The second lesson from capital market history is that there is a direct link between and reward.
risk
Arrange the following investments from highest to lowest return based on what our study of capital market history has revealed about risk premiums.
small-company longterm us. treasury
Geometric averages are ______ arithmetic averages.
smaller than
The principle of diversification tells us that spreading an investment across a number of assets will eliminate Blank______ of the risk.
some
The first step to calculate the variances of the returns on two stocks is to determine the deviations from the expected return.
square
The standard deviation is the ______ of the variance.
square root
Kate Corporation has discovered a very secret new product, but hasn't yet announced the discovery to the public. If the stock price reacts before the announcement (assuming no corporate "leaks"), the market is _____ form efficient.
strong
Capital weights can be interpreted just like portfolio weights.
structure
The cost of capital is an appropriate name since a project must earn enough to pay those who ______ the capital.
supply
A normal distribution has a ______ shape.
symmetrical
Some important characteristics of the normal distribution are that it is:
symmetrical bell-shaped
The risk principle argues that the market does not reward unnecessary risk that is taken on by the investor.
systematic
When an investor is diversified only ________ risk matters.
systematic
The systematic risk principle argues that the market does not reward risks _____
that are borne unnecessarily
The systematic risk principle argues that the market does not reward risks _____.
that are borne unnecessarily
The geometric average rate of return is approximately equal to ___.
the arithmetic mean minus half of the variance
Studying market history can reward us by demonstrating that _____.
the greater the potential reward is, the greater the risk on average, investors will earn a reward for bearing risk
The portfolio weight is _____.
the percentage of the total value that is invested in an asset
The standard deviation is ___.
the square root of the variance
Finding a firm's overall cost of equity is difficult because _____.
there is no way of directly observing the return that the firm's equity investors require on their investment
True or false: The existence of traders attempting to beat the market is a necessary precondition for markets to become efficient.
true
Average returns can be calculated _____.
two different ways
The true risk of any investment is the _____ portion.
unanticipated
The risk that affects a single asset or a small group of assets is ______ risk.
unsystematic
For a well-diversified portfolio, the Blank______ risk is negligible.
unsystematic diversifiable unique
The is the squared standard deviation.
variance
The square of the standard deviation is equal to the ____.
variance
A distribution tends to have a smooth shape when the number of observations is ___.
very large
The percentage of a portfolio's total value that is invested in a particular asset is the portfolio .
weight
The efficient markets hypothesis contends that _____ capital markets such as the NASDAQ are efficient.
well-organized
One of the disadvantages of using historical returns to estimate the market risk premium is that the past may not be a good guide to the future _____.
when economic conditions change quickly
The dividend is defined as the annual dividend amount divided by the beginning stock price.
yeild
A firm's cost of debt can be ___.
*obtained by checking yields on publicly traded bonds *estimated easier than its cost of equity *obtained by talking to investment bankers
The SML approach requires estimates of the _____.
- market risk premium - beta coefficient
The risk of owning an asset comes from:
- unanticipated events - surprises
The risk-free asset has a beta of _____.
0.00
By definition, what is the beta of the average asset equal to?
1
If a security's expected return is equal to the expected return on the market, its beta must be ____
1
A projected IRR on a risky investment in the _____ percent range is not unusual.
10 to 20
The weighted average of the standard deviations of the assets in Portfolio C is 12.9%. Which of the following are possible values for the standard deviation of the portfolio?
12.9% 10.9%
Based on average historical returns shown in the text, small-company stocks increased in value by _____ percent in a typical year.
16
The probability of an outcome being within ± one standard deviation of the mean in a normal distribution is approximately ___ percent
68
The probability of an outcome being within ± one standard deviation of the mean in a normal distribution is approximately ___ percent.
68
Asset A has an expected return of 17 percent and standard deviation of 5 percent. Asset B has an expected return of 15 percent and standard deviation of 5 percent. Which asset would a rational investor choose? Multiple choice question.
A
According to the CAPM, which of the following events would affect the return on a risky asset?
A change in the yield on T-bills A strengthening of the country's currency Federal reserve actions that affect the economy
Which of the following is true?
A company can deduct interest paid on debt when computing taxable income.
If the market changes and stock prices instantly and fully reflect new information, which time path does such a change exhibit
An efficient market reaction
A firm is exposed to both systematic and unsystematic risks. Which of the following are examples of systematic risks?
An increase in the Federal funds rate An increase in the corporate tax rate
Assets A and B each have an expected return of 10 percent. Asset A has a standard deviation of 12 percent while Asset B has a standard deviation of 13 percent. Which asset would a rational investor choose? Multiple choice question.
Asset A
Which of the following are true?
Book values are often similar to market values for debt. Ideally, we should use market values in the WACC.
Which of the following are ways to make money by investing in stocks? (Select all that apply.)
Capital gains Dividends
Which of the following are examples of unsystematic risk?
Changes in management Labor strikes
Which of the following are components used in the construction of the WACC?
Cost of preferred stock Cost of common stock Cost of debt
Which of the following are tax-deductible to the firm?
Coupon interest paid on bonds
What can we say about the dividends paid to common and preferred stockholders?
Dividends to common stockholders are not fixed. Dividends to preferred stockholders are fixed.
What is the equation for the capital asset pricing model?
Expected return on security = Risk-free rate + Beta × (Return on market - Risk-free rate)
True or false: Based on capital market history, market efficiency shows us that it is relatively simple to identify stocks that are incorrectly priced.
False
Which of the following are examples of systematic risk?
Future rates of inflation Regulatory changes in tax rates
Based on the historical returns shown in the text, the average was 2.9 percent per year over the 94-year span depicted.
Inflation
Which of the following are examples of a portfolio?
Investing $100,000 in a combination of U.S. and Asian stocks Holding $100,000 investment in a combination of stocks and bonds Investing $100,000 in the stocks of 50 publicly traded corporations
What does the security market line depict?
It is a graphical depiction of the capital asset pricing model. It shows the relationship between expected return and beta.
What is systematic risk?
It is a risk that pertains to a large number of assets.
What is the definition of expected return?
It is the return that an investor expects to earn on a risky asset in the future.
As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
It may eventually be almost totally eliminated. It is likely to decrease.
The formula for calculating the cost of equity capital that is based on the dividend discount model is:
RE = D1/P0 + g
The formula for the required return from the SML is:
RE = Rf + B(RM − Rf)
Mona Corporation has a variance of returns of 343, while Scott Corporation has a variance of returns of 898. Which company's actual returns vary more from their mean return?
Scott Corporation
The ratio is calculated as the risk premium of the asset divided by the standard deviation.
Sharpe
Which type of risk is unaffected by adding securities to a portfolio?
Systematic risk
Which one of the following types of risk is not reduced by diversification?
Systematic, or market risk
Which type of risk does not change as we add more securities to a portfolio?
Systematic, or market, risk
A firm faces many risks. Which of the following are examples of unsystematic risks faced by a firm?
The death of the CEO A hostile takeover attempt by a competitor
Which of the following methods for calculating the cost of equity ignores risk?
The dividend growth model
What are the two components of the market risk premium?
The expected return on the market The risk-free rate
What is the expected return on a security with beta of 1?
The expected return on the market.
What is the slope of the security market line (SML)
The market-risk premium
What is the slope of the security market line (SML)?
The market-risk premium
Which of the following are needed to describe the distribution of stock returns?
The mean return The standard deviation of returns
Using the SML approach, what is the expected return on a stock if its beta is equal to zero?
The risk-free rate
What is the intercept of the security market line (SML)?
The risk-free rate
According to the capital asset pricing model (CAPM), what is the expected return on a security with a beta of zero?
The risk-free rate of return
What are the two components of unexpected return (U) in the total return equation?
The systematic portion The unsystematic portion
How are the unsystematic risks of two different companies in two different industries related?
There is no relationship.
True or false: The return an investor in a security receives is equal to the cost of the security to the company that issued it.
True
Which one of the following is true?
Under U.S. tax law, a corporation's interest payments are deductible for tax purposes.
What does WACC stand for?
Weighted average cost of capital
If you wish to create a portfolio of stocks, what is the required minimum number of stocks?
You must invest in stocks of more than one corporation.
Given the definitions above, the weighted average cost of capital formula can be written as:
[S/(S + B)] × RS + [B/(S + B)] × RB × (1 − Tc)
More volatility in returns produces ______ difference between the arithmetic and geometric averages.
a larger
The calculation of a portfolio beta is similar to the calculation of _____.
a portfolio's expected return
Based on the capital asset pricing model (CAPM) there is generally ___ relationship between beta and the expected return on a security.
a positive
The WACC is the weighted average of the cost of equity and the _____.
aftertax cost of debt
In an efficient market:
all investments are zero NPV investments assets are priced at the present value of their future cash flows
Percentage returns are more convenient than dollar returns because they ____.
apply to any amount invested
The dividend yield for a 1-year period is equal to the annual dividend amount divided by the ______.
beginning stock price
The coefficient is the amount of systematic risk present in a particular risky asset relative to that in an average asset.
beta
The gains yield can be found by taking the difference between the ending stock price and the initial stock price and dividing it by the initial stock price.
capital
If you buy a stock for $10 and later sell it for $16, you will have a ____.
capital gain of $6
The total dollar return is the sum of dividends and __________.
capital gains or losses
When a company declares a dividend, shareholders generally receive ______.
cash
A firm's overall cost of capital will include both its cost of capital and equity capital.
debt
The cost of can be observed because it is the interest rate the firm must pay on new loans.
debt
Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio _____.
declines
The increase in the number of stocks in a portfolio results in a(n) in the average standard deviation of annual portfolio returns.
decrease
When new securities are added to a portfolio, the total unsystematic risk portion of that portfolio is most likely to _____.
decrease
Finding a firm's overall cost of equity is
difficult
Historically, there is a(n) ______ relationship between risk and expected return in the stock market.
direct
To apply the dividend growth model to a particular stock, you need to assume that the firm's ___ will grow at a constant rate.
dividend
The two potential ways to make money as a stockholder are through ______ and capital appreciation.
dividends
The two potential ways to make money as a stockholder are through ______ and capital appreciation. Multiple choice question.
dividends
The total dollar return on a stock is the sum of the ____ and the _____.
dividends; capital gains
The return an investor in a security receives is ______ the cost of the security to the company that issued it.
equal to
The _ return is the return that an investor will probably earn on a risky asset in the future.
expected
In an efficient market, firms should expect to receive ______ value for securities they sell.
fair
Which of the following is a conclusion that can be drawn regarding market efficiency from capital market history?
future market prices are hard to predict based on publicly available information
Average returns can be calculated using or arithmetic average.
geometric
The underlying key assumption, and oftentimes a key disadvantage, of the dividend growth model is that it assumes the dividend _____.
grows at a constant rate
The second lesson from studying capital market history is that risk is _____.
handsomely rewarded