Fin 102 Exam 2 HW Review - Chapters 7, 8 ,9, 20

Aliber's common stock is selling at $97 and a 1 month call option on the stock is $4. The exercise price is $100. The risk-free rate is 8% per year. What is the price of a 1 month put with an exercise price of $100. Assume options are European options. A. $5.79 B. $6.36 C. $7.05 D. $7.84 E. $8.11

$6.36

A project has an expected risky cash flow of $1,580 in year 5. The risk-free rate is 2.8 percent, the expected market rate of return is 18 percent, and the project's beta is 1.10 . Calculate the certainty equivalent cash flow for year 5, CEQ5. A. $812.03 B. $743.74 C. $772.39 D. $830.48 E. $701.28

$743.74

Suppose a project generates revenues averaging $830,000 per year perpetually. Variable costs are always proportional to revenues, equal to 30% of revenue. There are no other operating costs. The cost of capital is 14%. Your firm's long-term borrowing rate is 6%. A company proposes a fixed-price contract to cover costs at $220,000 per year for 10 years. Find the PV of the project with and without the fixed cost contract (with contract ; without contract). A. ($3,829,594 ; $4,150,000) B. ($3,127,404 ; $3,699,381) C. ($3,418,941 ; $3,682,039) D. ($3,183,472 ; $3,491,333) E. ($4,026,552 ; $4,483,500)

($3,829,594; $4,150,000)

Suppose that there are 2 macroeconomic factors and the expected risk premium is 12% on factor 1 and 6% on factor 2. You hold a portfolio of three stocks with the following factor betas: Stock A: b1= 1.2 and b2= 0.7 Stock B: b1= 0.5 and b2= -1.2 Stock C: b1= 0.4 and b2= -0.4 Suppose you buy $80 of A and $60 of B and short (sell) $40 of C. What is the factor beta of your portfolio to each of the two factors? and What is the expected risk premium of the portfolio? (portfolio b1, portfolio b2, expected risk premium) [Hint: find the portfolio weights based on the total value of the portfolio= $80 + $60 - $40=$100] A. (0, 1, 6%) B. (1, 1, 18%) C. (1, 0, 12%) D. (0, 1.1, 6.6%) E. (1.1, 0, 13.2%)

(1.1, 0, 13.2%)

Imagine that there are only two pervasive macroeconomic factors. Investment X and Y have the following sensitivities to these factors b1 and b2. X: b1= 0.5 and b2= 0.3 Y: b1= 1.2 and b2= - 0.2 We assume that the expected risk premium is 5% on factor 1 and 11% on factor 2. The risk free rate is 3.3%. According to APT, what is the risk premium on each of the stocks (risk premium X, risk premium Y)? A. (6.7%, 6.6%) B. (5.8%, 6.6%) C. (9.1%, 6.6%) D. (3.4%, 3.8%) E. (5.8%, 3.8%)

(5.8%, 3.8%)

The historical returns for Olmstead's stock from 2018 to 2022 are as follows: 13%,7%, -9%, 16%, and 4% Find the arithmetic average and geometric average? (arithmetic, geometric) A. (5.83%, 5.91%) B. (6.20%, 5.83%) C. (5.20%, 5.95%) D. (6.20%, 5.95%) E. (5.91%, 6.20%)

(6.20%, 5.83%)

Aliber Co want to test the market for a new product for one year at an initial cost of $800,000. The purpose of this test launch is to reveal consumer preferences and the test will not generate profit. There is a 30% chance that demand will be satisfactory to follow with additional investment. In this case, Aliber will spend $2.7 million to launch the new product and generate an expected annual profit of $500,000 in perpetuity. If demand is not satisfactory, the product will be withdrawn. Once preferences are known, the product will be subject to an average degree of risk, and therefore, Aliber requires a return of 9% on its investment. However, the initial test-market phase is viewed as much riskier and demands 23% on this initial expenditure. What is the NPV? (Hint: year 1 is the "risky" year and years 2 onwards is the years with the usual risk) A. -$141,238 B. -$114,222 C. -$103,523 D. -$106,286 E. -$132,801

-$103,523

What is the variance of a portfolio with 36% invested in Stock A and 64% in Stock B? Stock A: E(r)=15% and Standard deviation=22% Stock B: E(r)= 8% and Standard deviation=10% Correlation between Stock A and B = 0.6 A. 0.0125 B. 0.0165 C. 0.0198 D. 0.0232 E. 0.0251

0.0165

Suppose we have a bond issue currently outstanding that has 25 years left to maturity. The coupon rate is 9%, and the coupons are paid semiannually. The bond is currently selling for $908.72 per $1000 bond. What is the cost of debt?

0.100000044 (10.00%)

Find the portfolio beta given $2400 invested in A with beta =.84, $1900 invested in B with beta=1.6, $560 invested in C with beta 0.45, and $1000 invested in a risk-free asset.

0.905802

What is the beta of on a stock with an expected return of 17.3% given the risk-free rate is 1.8% and the expected return on the market is 11.25%? A. 1.22 B. 1.48 C. 1.55 D. 1.64 E. 1.82

1.64

What is the expected return of a portfolio with 36% invested in Stock A and 64% in Stock B? Stock A: E(r)=15% and Standard deviation=22% Stock B: E(r)= 8% and Standard deviation=10% Correlation between Stock A and B = 0.6 A. 10.52% B. 11.36% C. 12.12% D. 12.88% E. 14.16%

10.52%

MM Ferguson's market value of common stock is $21.5million, and its risk-free debt is $10.5 million in market value. The beta of the company's common stock is 1.26, and the market risk premium is 9.3 percent. If the Treasury bill rate is 2.8 percent, what is the company's cost of capital? (Ignore taxes) A. 11.18% B. 10.67% C. 9.42% D. 11.49% E. 12.23%

10.67%

A company is 40% financed by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company's common stock is 0.5. What is the after-tax WACC, assuming that the company pays tax at a 20% rate?

11.60%

The expected return on JK stock is 15.78% while the expected return on the market is 11.34%. The stock's beta is 1.51. What is the risk-free rate of return?

2.6341%

Common stocks of J-Li Jeans will have -7% return in an economic boom, 3% return in normal economic conditions and 15.2% return in a recession. The probability of a normal economy is 25% and the probability of a recession is 35%. What is the expected return? A. 2.25% B. 2.68% C. 3.27% D. 3.88% E. 4.31%

3.27%

The market portfolio's historical returns for the past five years were 19.2%, 6.3%, 27.3%, -13.9%, and -4.3%. Estimate the market risk premium when the risk-free rate is 2.2%. A. 9.12% B. 8.83% C. 6.86% D. 6.32% E. 4.72%

4.72%

Olmstead Inc. has a target D/E ratio =0.45. The cost of equity is 12.4% and the pretax cost of debt is 4.1%. What is the cost of capital given a tax rate of 21%? A. 10.45% B. 11.98% C. 7.27% D. 8.28% E. 9.56%

9.56%

Common stocks of J-Li Jeans will have -7% return in an economic boom, 3% return in normal economic conditions and 15.2% return in a recession. The probability of a normal economy is 25% and the probability of a recession is 35%. What is the expected return? What is the standard deviation? A. 7.57% B. 7.91% C. 8.85% D. 9.59% E. 11.03%

9.59%

Rank the following stocks from the highest to lowest alpha, given the risk-free rate of 2.9 percent and the market risk premium of 8.3 percent [Hint: alpha is the difference between the actual and expected return] Stock A : Beta=0.46 and actual return=6.28% Stock B: Beta=0.85 and actual return=11.76% Stock C: Beta=1.00 and actual return=12.91% Stock D: Beta=1.33 and actual return=13.80% A. A>C>D>B B. C>D>B>A C. B>C>D>A D. D>A>B>C E. C>B>A>D

B>C>D>A

Which one of the following is most directly affected by the level of systematic risk in a security? A. Market risk premium B. Expected rate of return C. Risk-free rate D. Standard deviation of the returns E. Volatility of the returns

Expected rate of return

True/False: A risk-free asset offers positive risk premium.

False

True/False: A sensible way for a manager to account for overoptimistic cash-flow forecasts is to adjust the discount rate.

False

True/False: A straddle strategy is a bet on low stock price volatility.

False

True/False: Diversification reduces all of the risk in individual assets.

False

True/False: Firms with cyclical revenues tend to have lower asset betas.

False

True/False: If you write a call option, you acquire the right to sell stock at a fixed strike price.

False

Which one of the following is represented by the slope of the security market line? A. Beta coefficient B. Expected rate of return C. Market risk premium D. Market standard deviation E. Risk-free interest rate

Market risk premium

Jimin's Cricket Farm issued a 30-year, 7% of semiannual bond 3 years ago. The bond currently sells for 93% of its face value. The company's tax rate is 21%.What is the pre-tax cost of debt? What is the after-tax cost of debt?

Pre-tax: 0.076147638 (7.61%); After-tax: 0.060156634 (6.02%)

True/False: All else equal, investors prefer to choose from portfolios having higher Sharpe ratios.

True

True/False: All else equal, the closer an option gets to expiration, the lower the option price.

True

True/False: An analyst should evaluate each project at its own opportunity cost of capital. The true cost of capital depends on the particular use of that capital, in other words, what project it is used in, what the cash flows for that project look like.

True

True/False: Arbitrage opportunities have zero risk to return.

True

True/False: Arbitrage pricing theory implies that if there is an arbitrage opportunity, an investor should short sell the expensive asset (low return) buy the cheaper asset (high return).

True

True/False: Eliminating unsystematic risk is the responsibility of the individual investor.

True

True/False: Risky projects can be evaluated by discounting certainty equivalent cash flows at the risk-free interest rate.

True

True/False: Systematic risk is compensated for by the risk premium.

True

True/False: The standard deviation of a portfolio is always less than the weighted average of the standard deviations of the individual securities held in that portfolio if the correlation coefficient is less than 1.

True

True/False: The systematic risk of the market is always measured by a beta of 1.

True

True/False: The writer of a put option loses if the stock price declines.

True

The capital structure weights used in computing a company's weighted average cost of capital: A. depend on the financing obtained to fund each specific project. B. remain constant over time unless new securities are issued or outstanding securities are redeemed. C. can only include debt and common stock. D. are based on the market values of the outstanding securities. E. are based on the book values of debt and equity.

are based on the market values of the outstanding securities.

The slope of the regression line on a graph of common stock returns on the y-axis and market returns on the x-axis represents: A. alpha B. beta C. R-squared D. standard error E. standard deviation

beta

In a multifactor APT model, the coefficients on the macro factors are often called A. systematic risk B. factor sensitivities C. idiosyncratic risk D. factor betas E. factor sensitivities and factor betas

factor sensitivities and factor betas

If a company uses its WACC as the discount rate for all of the projects it undertakes then the company will tend to: A. accept all positive net present value projects. B. reject all high-risk projects. C. increase the average risk level of the company over time. D. reject all negative net present value projects. E. favor low-risk projects over high-risk projects.

increase the average risk level of the company over time.

If a stock portfolio is well diversified, then the portfolio variance: A. will equal the variance of the most volatile stock in the portfolio. B. must be equal to or greater than the variance of the least risky stock in the portfolio. C. will be a weighted average of the variances of the individual securities in the portfolio. D. will be an arithmetic average of the variances of the individual securities in the portfolio. E. may be less than the variance of the least risky stock in the portfolio.

may be less than the variance of the least risky stock in the portfolio.

The maximum value of a call option can never exceed the: A. underlying stock price. B. exercise price plus the stock price. C. strike price. D. premium price. E. intrinsic value.

underlying stock price.

According to the capital asset pricing model, fairly priced securities have ________. A. negative betas B. positive alphas C. positive betas D. zero alphas E. negative alphas

zero alphas