Corporate Finance Chapter 11

T/F: Calculating the expected return is the last step in the computation of variance

False

T/F: Portfolio weights can be defined as the dollars invested in each asset

False

T/F: Since the CAPM equation can be used only for individual securities, it cannot be used with portfolios.

False

T/F: The surprise part of any announcement is the information the market uses to form the expectation of the return on the stock.

False

Which of the following are examples of information that may impact the risky return of a stock? -Last year's net income as a percentage of sales and gross fixed assets. -The outcome of an application currently pending with the Food and Drug Administration. -The Fed's decision on interest rates at their meeting next week -The trend in sales growth over the last 10 years

The outcome of an application currently pending with the Food and Drug Administration The Fed's decision on interest rates at their meeting next week

T/F: Unsystematic risk is specific only to a single company or industry.

True

What is the expected return for a security if the risk-free rate is 5%, the expected return on the market is 9%, and the security's beta is 1.5? 6.5% 11% 13.5% 4%

11%

The CAPM can also be used for a portfolio by first determining the portfolio's _______

Beta

The capital asset pricing model is the equation of the security market line showing the relationship between expected return and _______

Beta

The ________ return on a portfolio is a combination of the expected returns on the assets in the portfolio

Expected

T/F: A well-diversified portfolio will eliminate all risks.

False

T/F: Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio increases.

False

T/F: Labor strikes are an example of systematic risk.

False

What does the security market line depict? -It depicts the relationship between systematic risk and unsystematic risk. -It depicts the relationship between the return on the S&P 500 and an individual security's return. -It depicts the relationship between expected return and the standard deviation of returns. -It is a graphical depiction of the capital asset pricing model.

It is a graphical depiction of the capital asset pricing model

____________ risk is the only risk important to the well diversified investor. Firm-specific Unsystematic Systematic Diversifiable

Systematic

What is the slope of the security market line (SML)? The risk-free rate of return The market-risk premium The expected return on market The expected return on the market plus the risk-free rate of return

The market-risk premium

The minimum required return on a new project is known as the: cost of capital payback period internal rate of return capital of cost

cost of capital

An investment will have a negative NPV when its expected return is _______ ________ what the financial markets offer for the same risk. equal to less than greater than

less than

Systematic risk will ____ when securities are added to a portfolio decrease not change increase be eliminated

not change

The security market line (SML) shows that the relationship between a security's expected return and its beta is ____ positive insignificant negative overrated

positive

Beta tells us the amount of ________ risk of an asset or portfolio relative to ______ systematic; an average risky asset systematic; the risk-free asset unsystematic; the risk-free asset unsystematic; an average risky asset

systematic; an average risky asset

Which of the following are examples of unsystematic risk? Labor strikes The expected rate of inflation next year Changes in management Changes in the federal tax code

Labor strikes Changes in management

The appropriate discount rate to use to evaluate a new project is the ____ risk free rate cost of capital average market return

cost of capital

Systematic risk is also called ______________ risk diversifiable market world-wide industry-specific

market

If an asset has a reward-to-risk ratio of 6.0%, that means it has a __________ of 6.0% per unit of ______ return; risk risk premium; systematic risk return; systematic risk systematic risk; risk premium

risk premium; systematic risk

The _____ is the news that influences the unanticipated return on the stock known item surprise joint concern false information

surprise

T/F: The expected return of a portfolio is a combination of the weights of each asset in a portfolio.

False

What is a risk premium? -It is a fee charged to investors by the SEC that allows them to invest in risky securities. -It is the return on risk-free securities. -It is a numerical estimate of beta. -It is additional compensation for taking risk, over and above the risk-free rate.

It is additional compensation for taking risk, over and above the risk-free rate.

Which of the following are examples of systematic risk? Regulatory changes in tax rates An increase in competition in the industry Future rates of inflation Labor strikes

Regulatory changes in tax rates Future rates of inflation

By definition, what is the beta of the average asset equal to? 0 Between 0 and 1 2 1

1

What is the intercept of the security market line (SML) Beta The market rate of return The market-risk premium The risk-free rate

The risk-free rate

T/F: According to the capital asset pricing model (CAPM), the risk-free rate of return is the expected return on a security with a beta of zero.

True

The true risk of any investment comes from _____________ anticipated events surprises expected return errors

surprises

Even if the portfolio is well diversified, the investor is still exposed to _____ risk unknown multiplied mean systemati

systematic

The return expected on an investment depends only on the asset's _____ risk unsystematic diversifiable unnatural systematic

systematic

To determine the appropriate required return for an investment, we can use ___________________ the risk free rate the lowest going rate the Security Market Line the average return on the market

the Security Market Line

If the standard deviation of a portfolio is _________ the square root of the variance the variance plus inflation the variance squared the expected return squared

the square root of the variance

T/F: The slope of the SML is the market-risk premium (expected return on the market minus the risk-free rate of return).

False

T/F: The standard deviation is the variance squared

False

What is unsystematic risk? It is a risk that is always caused by external factors. It is a risk that affects a single asset or a small group of assets. It is a risk that is unavoidable. It is a risk that affects all the assets in a diversified portfolio.

It is a risk that affects a single asset or a small group of assets

As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk? It is likely to decrease. It will not change. It may eventually be almost totally eliminated. It is likely to increase

It is likely to decrease It may eventually be almost totally eliminated.

What is an uncertain or risky return? -It is the portion of return that is unaffected by present or future information. -It is the portion of return that depends on information that is currently unknown. -It is the return that is classified as risky by bond rating agencies. -It is the portion of return that depends on information that is currently known

It is the portion of return that depends on information that is currently unknown

Which of the following types of risk is not reduced by diversification? Unique risk Asset-specific risk Unsystematic risk Systematic, or market risk

Systematic, or market risk

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 The market risk premium The return on market Zero

The risk-free rate of return

How are the unsystematic risks of two different companies in two different industries related? There is a negative relationship. There is no relationship. There is a positive relationship. The relationship can be either positive or negative.

There is no relationship

T/F: The expected return is the return that an investor expects to earn on a risky asset in the future.

True

______ risk is reduced as more securities are added to the portfolio Marketwide Unsystematic Diversifiable Company-specific

Unsystematic Diversifiable Company-specific

What is the Reward-to-Risk Ratio? [Rf - E(RA)]/βA [E(RA) - Rf]/βA [E(RA) - βA]/Rf [E(RA) + Rf]/βA

[E(RA) - Rf]/βA [Expected Return -Risk Free Rate]/Beta

When a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means that the market reversed its position based on the news doesn't pay attention to news items already knew about most of the news item

already knew about most of the news item

Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio ________ declines fluctuates randomly increases does not change

declines