FI 801 Exam 2

What is the beta of a U.S. Treasury bill?

0

Which one of the following should earn the highest risk premium based on CAPM? A) Diversified portfolio with returns similar to the overall market B) Stock with a beta of 1.38 C) Stock with a beta of .74 D) Portfolio with 50% in the S&P 500 and 50% in a stocks with beta above 1.5. E) Portfolio with a beta of 1.01 Both B and D could be right based on the wording for D. Specifically, how much above 1.5 in option D is crucial. Of course, I will take either answer. The remaining three (A, C and E) are dominated by both B and D.

B or D

Which one of the following statements is correct? A) The subjective approach assigns a discount rate to each project based on other companies in the same category as the project. B) Overall, a company makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects. C) Companies will correctly accept or reject every project if they adopt the subjective approach. D) Mandatory projects should only be accepted if they produce a positive NPV when the overall company WACC is used as the discount rate. E) The pure play approach should only be used with low-risk projects.

B.

Unexpected Returns

Can either be positive or negative in the short term but tend to be zero over the long-term

What is the most logical explanation for a +2.0% return on a stock with a beta of 1.0 in a month where the market returned +1.0%?

Favorable firm-specific news was reported

If the slope of the line measuring a stock's historic returns against the market's historic returns is positive, then the stock:

Has a positive beta

If you were willing to bet that the overall stock market was heading up on a sustained basis, it would be logical to invest in:

High beta stocks; High beta stocks respond most sensitively to the market. In a market upswing, we would expect them to rise the most.

The ________ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly.

Risk premium

Diversification works because:

Unsystematic risk exists.

Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 65 percent of the company's overall sales. Division A is also the riskier of the two divisions. When management is deciding which of the various divisional projects should be accepted, the managers should:

assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.

The cost of equity for a company with a debt-equity ratio of .41:

is affected by either a change in the company's beta or its projected rate of growth.

A considerable scattering in the plot of points representing the total returns of a stock versus the returns on the market reflects the:

unique (i.e. firm-specific or idiosyncratic) risk of the stock.