FINA 320 Quiz 5

Over the past 75 years, which of following investments has provided the largest average return? a. Small company stocks b. Common stocks c. Treasury bills d. Treasury bonds e. Corporate bonds

a

Regarding diversification, _____________________________. a. most of the benefits are realized with about 20 to 30 stocks b. it is the process of increasing the riskiness associated with individual assets by spreading an investment across numerous assets c. the portfolio returns are reduced, and the standard deviation of that portfolio remains unchanged d. there is no limit to the amount of risk that can be eliminated through this process e. None of the above

a

The ________________ of returns is a measure of total risk a. standard deviation b. variance c. historical return d. ROI

a

The risk-return trade-off for a portfolio is measured a. expected return and standard deviation b. expected return divided by standard deviation c. expected return multiplied by standard deviation d. expected return and variance

a

The slope of an asset's security market line is the __________. a. market risk premium b. portfolio weight c. beta coefficient d. risk-free interest rate e. None of the above

a

We can use the individual costs of capital that we have computed to get our ___________ cost of capital for the firm. a. average b. risk c. difference d. return

a

What are risk premiums a. extra return for taking on the risk b. less return for taking on the risk c. A and B are correct d. Neither are correct

a

What does beta of 1 tell us? a. risk is the same systematic risk as overall market b. risk is less systematic risk than the overall market c. the risk is more systematic risk than the overall market

a

Which of the following is not a disadvantage of the dividend growth model a. Does not require additional training to ensure proper integration b.Only applicable to companies currently paying dividends c.Not applicable if dividends aren't growing at a reasonably constant rate d.Extremely sensitive to the estimated growth rate - an increase in g of 1% increases the cost of equity by 1% e.Does not explicitly consider risk

a

Which of the following regarding systematic risk statements is not true a. Risk factors that affect a small number of assets b. Risk factors that affect a large number of assets c. Also known as non-diversifiable risk or market risk d. Includes such things as changes in GDP, inflation, interest rates, etc.

a

1. All else the same, a higher corporate tax rate . a. will decrease the WACC of a firm with some debt in its capital structure b. will increase the WACC of a firm with some debt in its capital structure c. will not affect the WACC of a firm with some debt in its capital structure d. will decrease the WACC of a firm with no debt in its capital structure

a

1. The type of risk that we can diversify away is ____________ a. Unsystematic risk b. Systematic risk c. Nondiversifiable risk Market risk

a

1. ___________ refers to the way a company finances itself through some combination of loans, bond sales, preferred stock sales, common stock sales, and retention of earnings. a. Capital structure b. Cost of capital c. Working capital management d. NPV

a

1. Suppose that the Federal Reserve takes actions that cause the risk-free rate to fall. All else the same, we would expect a firm's cost of equity to . a. increase if we are using the SML b. decrease if we are using the SML c. either increase or decrease if we are using the SML, but we can't determine which without more information d. increase if expected return on the market decreases e. decrease if the firm's beta increases

b

1. When firms develop a WACC for individual projects based on the cost of capital for other firms in similar lines of business as the project, the firm is utilizing a: a. subjective risk approach b. pure play approach c. divisional cost of capital approach d. capital adjustment approach

b

1. Which of the following describes a stock that plots above the security market line? a. The price of the stock is too high b. The expected return of the stock is too high c. The stock's beta is too high. d. The stock provides a return that is less than the average return on the market

b

1. Which of the following is false regarding risk and return? a. The risk-free asset earns the lowest expected rate of return. b. The reward for bearing risk is known as the standard deviation. c. Based on historical data, there are rewards for bearing risk. d. An increase in the risk of an investment will result in an increased risk premium.

b

1. Which of the following is false regarding the estimation of a firm's cost of equity capital? a. There are models that will provide reasonable estimates. b. The cost of equity is equal to the weighted average cost of capital. c. The cost of equity depends on the systematic risk of the firm's equity. d. All of the above

b

Although non-systematic risk is present in differing amounts, individual stocks are: A. Exposed to the same amount of systematic risk B. Exposed to differing amounts of systematic risk C. Not exposed to systematic risk; only the general economy is subject to systematic risk. D. Able to diversify away their systematic risk. E. None of the above

b

If we are looking at a project that does ______ have the same risk as the firm, then we need to determine the appropriate discount rate for that project a. is b. not c. less than d. more than

b

Security - return - Sd - beta A - 16% - 20% - 1.2 B - 12% - 25% - 0.8 which of A and B has the least total risk? The least systematic risk? a. A; A b. A; B c. B; A d. B; B

b

The cost of equity is the ____________ by equity investors given the risk of the cash flows from the firm a. investment required b. return required c. risk required d. All of the above

b

What does beta < 1 tell us? a. risk is the same systematic risk as overall market b. risk is less systematic risk than the overall market c. the risk is more systematic risk than the overall market

b

What is a portfolio a. a collection of stocks b. a collection of assets c. a collection of bonds d. a collection of treasury bonds

b

What is the typical relationship between the return standard deviation of an individual common stock and the return standard deviation of a diversified portfolio common stock? A. The individual stock's return standard deviation is lower. B. The individual stock's return standard deviation is higher. C. The return standard deviations should be equal. D. There is no way to predict this relationship E. None of the above.

b

Which of the following is false regarding risk and return? a. The risk-free asset earns the lowest rate of return. b. The reward for bearing risk is known as the standard deviation. c. Based on historical data, there are rewards for bearing risk. d. An increase in the systematic risk of an investment will result in an increased risk premium. e. None of the above

b

Which of the following is not a disadvantage of SML a. Have to estimate the expected market risk premium, which does vary over time b. Applicable to all companies, as long as we can compute beta c. Have to estimate beta, which also varies over time d. We are relying on the past to predict the future, which is not always reliable

b

Which of the following statements regarding systematic risk is not true a. There is a reward for bearing risk b. The expected return on a risky asset depends only on that asset's systematic risk since unsystematic risk cannot be diversified away c. There is not a reward for bearing risk unnecessarily d. The expected return on a risky asset depends only on that asset's systematic risk since unsystematic risk can be diversified away

b

•Portfolio variance is _______ the weighted average of the variance of each of the stock in the portfolio. a. is b. not c. less than d. more than

b

•The cost of debt is ________ the coupon rate a. is b. not c. less than d. more than

b

1. A firm that uses its WACC as a cutoff without consideration of project risk: a. Tends to become less risky over time. b. Tends to reject more negative NPV projects over time. c. Likely will see its WACC rise over time. d. Will only accept projects where the IRR is equal to the WACC.

c

1. Stock A has a beta coefficient of 0.9, and stock B has a beta coefficient of 1.2. Which of the following statements is false regarding these two stocks? a. Stock A is less risky from the market's perspective than a typical stock, and stock B is more risky than a typical stock. b. Stock B, if purchased, will increase the market risk of a portfolio more than stock A would (if purchased). c. Stock A necessarily must have a lower standard deviation of returns than stock B. d. Stock B must have a higher expected return than stock A if both of them are priced properly.

c

1. The relevant risk for the fair market pricing of financial securities is the . a. standard deviation of the investment's return b. total risk c. systematic risk d. non-systematic risk

c

1. Which of the following is false concerning diversification? Assume that the securities being considered for selection into a portfolio are not perfectly correlated. a. As more securities are added to the portfolio, the unsystematic risk of the portfolio declines. b. As more securities are added to the portfolio, the total risk of the portfolio declines. c. As more securities are added to the portfolio, the systematic risk of the portfolio declines. d. As more securities are added to the portfolio, the portfolio risk eventually approaches the level of systematic risk in the market.

c

A firm is considering an investment in a project whose risk is greater than the current risk of the firm. Based on any method for assessing risk. In evaluating this asset the decision maker should: A. Increase the IRR to reflect the greater risk B. Increase the NPV to reflect the greater risk C. Increase the cost of capital used to evaluate the project to reflect the projects higher risk. D. None of the above

c

A stock's risk premium is equal to the: A. Expected market return times beta. B. Treasury bill yield plus expected market return. C. Risk free rate plus expected market risk premium. D. Expected market risk premium times beta. E. None of the above.

c

Risk premium of market portfolio; the _____________ between the market return and the return on risk-free Treasury bills. a. multiplication b. division c. difference d. addition

c

The _______________ is the required return on our _______________ a company's debt; risk of return b. risk of return; company's debt c. cost of debt; company's debt d. company's debt; cost of debt

c

The objective of diversification is to _____________ the risk (or return variance) of a portfolio _____________ an equivalent reduction in expected returns a. increase, without b. reduce; with c. reduce; without d. increase; with

c

The standard deviation for historical stock returns can be calculated as: a. The positive square root of the average return. b. The average difference between the actual return and the average return. c. The positive square root of the variance. d. The average return divided by N minus one, where N is the number of returns. e. The variance squared.

c

Variance and standard deviation measure the ____________ a. historical variance b. standard deviation c. volatility of asset returns d. volatility of investment return

c

What does beta > 1 tell us? a. risk is the same systematic risk as overall market b. risk is less systematic risk than the overall market c. the risk is more systematic risk than the overall market

c

Which are considered to be risk free a. stocks b. Amazon stock c. treasury bonds d. coupon bonds

c

1. Bradshaw Steel has a capital structure with 30 percent debt (all long-term bonds) and 70 percent common equity. The coupon rate on the company's long-term bonds is 8 percent and the bond is sell at a premium. The firm estimates that its overall composite WACC is 10 percent. The risk-free rate of interest is 5.5 percent, the market risk premium is 5 percent, and the company's tax rate is 40 percent. Bradshaw uses the CAPM to determine its cost of equity. What is the beta on Bradshaw's stock? a. 0.64 b. 1.07 c. 1.35 d. Cannot be solved because not enough information is provided e. None of the above

d

1. The cost of debt capital for a firm . a. is equal to the current yield (not YTM) on the firm's outstanding bonds b. can be calculated by estimating the beta of the firm's equity and then using the SML c. can be calculated by looking at the coupon rates on existing bonds of similar risk d. can be estimated even if the firm's bonds are not publicly traded, by looking at the yield to maturity on bonds outstanding from peer group firms with similar ratings and maturity.

d

1. Which of the following would likely have the greatest amount of systematic risk? a. A portfolio of the common stocks of 100 randomly-selected companies. b. The market portfolio. c. A portfolio half invested in the market portfolio and half invested in Treasury bills. d. A portfolio half invested in the market portfolio and half invested in stocks with betas = 1.50.

d

Investment with a high variance has a higher chance of _______ return a. higher b. lower c. negative d. B and B are correct

d

Portfolio diversification is the _____________ in _____________ different asset classes or sectors a. investment; less than the investment of b. investment; few c. return; several d. investment; several

d

Standard deviation is one of the most common measures of . a. the normal distribution b. the inflation rate c. the risk premium d. return volatility

d

The cost of debt capital for a firm _________. A. It is equal to the current yield (not YTM) on the firm's outstanding bonds. B. Can be calculated by estimating the beta of the firm's equity and then using SML. C. Can be calculated by looking at the coupon rates on existing bonds of similar risk. D. Can be estimated even if the firm's bonds are not publicly traded, by looking at the yield to maturity on bonds outstanding from peer group firms with similar ratings and maturity. E. None of the above

d

The principle of diversification tells us that: a. Concentrating an investment in two or three large stocks will eliminate all of your risk. b. Spreading an investment across many diverse assets cannot (in an efficient market) eliminate risk. c. Spreading an investment across many diverse assets will eliminate all of the risk. d. Spreading an investment across many diverse assets will eliminate some of the risk. e. None of the above.

d

The type of risk that can be diversified away is called. a. Diversifiable risk b. Unique risk c. Idiosyncratic risk d. All of the above

d

Using the WACC as our discount rate is only appropriate for projects that ___________________ risk as the firm's current operations a. are not similar b. are similar c. are not the same d. are the same

d

What is the security market line a. The relationship between expected return and historical variance b. The relationship between expected return and standard deviation c. The relationship between expected return and variance. d. The relationship between expected return and beta.

d

Which of the following would be considered an example of systematic risk? a. Intel reports record sales. b. Quarterly profit for GM equals expectations. c. Lower quarterly sales for IBM than expected. d. Greater new jobless claims than expected. e. None of the above

d

A stock has been held for one year, during which time its dividend yield was greater than its capital gains yield. For this stock, the percentage return is. A. Zero B. Negative C. Equals dividend yield D. Less than dividend yield. E. Cannot be determined

e