Finance Exam 3

Total Return Formula

((ending stock price - Initial stock price) + dividend) / initial price

What's the Fisher equation?

(1+R)= (1+r)*(1+h) or nominal rate= real rate *inflation rate

Portfolio Beta formula

(ST 1 amount / total invested* beta 1) + (ST 2 amount / total invested* beta 1)

What is the arithmetic average formula?

(Sum of Returns)/ # of returns

What the after tax cost of debt formula

(annual interest expense (FV*CR/#of payments ) * one minus tax rate (1-TC)) /current price

Which of the following statements are accurate? 1.I. Nondiversifiable risk is measured by beta. 2.II. The risk premium increases as diversifiable risk increases. 3.III. Systematic risk is another name for nondiversifiable risk. 4.IV. Diversifiable risks are market risks you cannot avoid.

1 and 3 only

how do you get dividend yield with the stock price, realized loss percent of investment, and capital loss?

1. get total loss per share by: realized percent loss * price. 2. Get dividend per share by: capital loss per share - total loss per share 3. get dividend yield by: dividend per share / price

If firm deploys debt then___ to wacc 1-4

1. wacc goes down if stock replaced with debt 2. if taxes decrease Wacc goes up 3. if tax rate goes down cost goes up 4. there is diff stuff that changes WACC

large cap firms have cap over ?

10 billion

historical avg return for large company stock

12.1%

historical avg return for us treasury bill

3.4%

What is true about market efficiency?

A firm will generally receive a fair price when it issues new shares of stock if the market is efficient.

What is the efficient market hypothesis?

All securities in an efficient market are zero net present value investments.

how do you get the annual interest with tax shield approach ?

Annual interest payment(FV*CR) *Tax rate (Tc)

Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Ignore taxes.

At the break-even point, there is no advantage to debt.

how do you gret squared deviation?

Deviation^2

What is the dividend yield formula?

Dividend Yield = Dividend/Stock Price

how do you get annual interest expense?

FV*CR/#of payments

True or False: If a market is efficient, arbitrage opportunities should be common.

False

True or False: Individual investors who continually monitor the financial markets seeking mispriced securities are never able to find a security that is temporarily mispriced.

False

True or False: New information will gradually be reflected in a stock's price to avoid any sudden price changes in an efficient market.

False

True or False: With respect to risk, Adding an additional stock to a diversified portfolio will lower the portfolio's beta.

False

True or False: With respect to risk, Every portfolio that contains 15 or more securities is free of unsystematic risk.

False

True or False: With respect to risk, Stocks that move in tandem with the overall market have beta values of zero.

False

True or false: a well-diversified portfolio's expected return is independent of the allocation of the portfolio amongst individual securities.

False

Hondros Corporation recently went public. The firm offered 42,000 shares and received net proceeds of $18.56 per share. Hirani & Tran served as the underwriter and sold 37,000 shares to the public at an offer price of $20.63 per share. What type of underwriting was this?

Firm commitment

Assume a portfolio contains stocks of 25 different companies, and the weights of each are unequal. Also assume the various potential economic states have unequal likelihoods of occurring. Which one of the following statements is accurate?

Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.

expected return and price are________

Inversely related

Which categories of securities had the highest average annual return for the period 1926-2019?

Small-company stocks

Which of the following statements best describes the principle of diversification?

Spreading an investment across many diverse assets will eliminate some of the total risk.

Which one of the following is a key goal of the aftermarket period? Collecting the largest number of Dutch auction bids as possible Determining a fair offer price Supporting the market price for a new securities issue Establishing a broad-based underwriting syndicate Distributing red herrings to as many potential investors as possible

Supporting the market price for a new securities issue

Assume a firm employs debt in its capital structure. Which of the following statements is accurate? The WACC would most likely decrease if the firm replaced its preferred stock with debt. ) In the WACC calculation, the weight assigned to preferred stock decreases as the market value of the preferred stock increases. ) The WACC will decrease as the corporate tax rate decreases. ) In the WACC calculation, the weight of equity is based on the number of shares outstanding and the book value per share. ) The WACC will remain constant unless a company retires some of its debt.

The WACC would most likely decrease if the firm replaced its preferred stock with debt.

Assuming a semi-strong market form of efficiency. What is the most likely reason why a stock price might not react at all on the day the new information related to the stock issuer is released?

The information was expected.

According to M&M Proposition II, without taxes, which of the following statements is accurate? The cost of equity remains constant as the debt-equity ratio increases. The cost of equity is inversely related to the debt-equity ratio. The required return on assets is equal to the weighted average cost of capital. Financial risk determines the return on assets. Financial risk is unaffected by the debt-equity ratio.

The required return on assets is equal to the weighted average cost of capital.

Which category of securities had the least volatile annual returns over the period of 1926-2019?

U.S. Treasury bills

Which category of securities had the lowest average risk premium for the period 1926-2019?

U.S. Treasury bills

Stock Alpha has a beta of .79 and a reward-to-risk ratio that is less than the reward-to-risk ratio of Stock Omega. Omega has a beta of 1.12. This information implies that:

either Alpha is overpriced or Omega is underpriced or both.

how do you get coupon amount ?

face value * coupon rate

t/f; Company contribution to the employees' retirement account will generally have the highest priority when assets are distributed in a bankruptcy proceeding.

false

Which one of the following is a direct cost of bankruptcy? Bypassing a positive NPV project to avoid additional debt Investing in cash reserves Maintaining a debt-equity ratio that is lower than the optimal ratio Losing a key company employee Paying an outside accountant to prepare bankruptcy reports

paying an outside accountant to prepare bankruptcy reports

Slope aka reward to risk ratio

(expected return - risk free rate)/ beta or risk premium / beta

When evaluating any capital project proposal, the cost of capital:

) depends upon how the funds raised for that project are going to be spent.

Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $3.36 per share and has a beta of 1.38, all else constant, which of the following actions will increase the firm's cost of equity?

A decrease in the risk-free rate

which is the best example of a diversifiable risk?

A firm's sales decrease

Index Fund

A mutual fund that tries to match the performance of a particular index by investing in the companies included in that index.

Which one of these statements related to Chapter 11 bankruptcy is accurate? Prepacks apply only to Chapter 7, not Chapter 11, bankruptcies. Senior management must be replaced prior to exiting a Chapter 11 bankruptcy. A company can only file for Chapter 11 after it becomes totally insolvent. Companies sometimes file for Chapter 11 in an attempt to gain a competitive advantage. Chapter 11 involves the total liquidation of the bankrupt firm.

Companies sometimes file for Chapter 11 in an attempt to gain a competitive advantage.

Which one of the following is a marketed claim against the cash flows of a company?

Dividend payment to shareholders

True or False: With respect to risk, The beta of a portfolio will increase when a stock with a high standard deviation is added to the portfolio.

False

Cervantes recently offered 60,000 new shares of stock for sale. The underwriters sold a total of 73,400 shares to the public at a price of $18.20 per share. The additional 13,400 shares were purchased in accordance with which one of the following? Green Shoe provision Red herring provision Quiet provision Lockup agreement Post-issue agreement

Green Shoe provision

Of the options listed below, which is the best example of systematic risk?

Investors panic causing security prices around the globe to fall precipitously.

Which of the following statements regarding unsystematic risk is accurate?

It can be effectively eliminated by portfolio diversification.

CAPM (Capital Asset Pricing Model)

Kcs = Rrf + B(Rm-Rrf) where Rrf = risk free rate, B = beta, Rm = return on the market, Rm-Rrf = risk premium

Which one of the following statements correctly applies to the period 1926-2019?

Long-term corporate bonds outperformed long-term government bonds.

What is the correct ranking of securities based on the volatility of their annual returns over the period of 1926-2019? Rank from highest to lowest.

Long-term government bonds, long-term corporate bonds, intermediate-term government bonds

If the labor union representing company da's employees unexpectedly called a strike. Would this be reflected in Company DA's expected returns ?

NO

With respect to returns, which one of the following statements is accurate?

Over time, the average unexpected return will be zero.

An investor wants to reduce the unsystematic risk in her portfolio. Which of the following actions is least likely to do so?

Reducing the number of stocks held in her stock portfolio

Which one of the following statements is correct concerning the direct costs of issuing securities? Domestic bonds are generally more expensive to issue than equity IPOs. The gross spread as a percentage of proceeds is the same for similar-sized IPOs and SEOs. A seasoned offering is always more expensive on a percentage basis than an IPO. There tends to be substantial economies of scale when issuing any type of security. The costs of issuing convertible bonds tend to be less on a percentage basis than the costs of issuing straight debt.

There tends to be substantial economies of scale when issuing any type of security.

True or False: With respect to risk, The systematic risk of a portfolio can be lowered by adding T-bills to the portfolio.

True

True or false: a well-diversified portfolio's expected return cannot exceed the expected return of the best performing security in the portfolio.

True

True or false: a well-diversified portfolio's expected return is independent of the unsystematic risks of the individual securities held in the portfolio.

True

True or false: a well-diversified portfolio's expected return must be equal to or greater than the expected return of the worst performing security in the portfolio.

True

t/f: Payment of employees' wages will generally have the highest priority when assets are distributed in a bankruptcy proceeding.

True

True or False: an increase in an unrealized gain will increase the capital gain yield.

True: the capital gains yield is found by seeing the change in the value of an investment (realized or unrealized) divided by its og price. So an increase in unrealized capital gain would still give you a higher capital gain yield

What is true about unexpected returns?

Unexpected returns can be either positive or negative in the short term but tend to be zero over the long term.

Standard deviation is a measure of which one of the following?

Volatility

Vl formula

Vu + (Tc * Debt amount)

If this morning company da confirmed that, as expected, the CFO is retiring at the end of the year. Would this be reflected in Company DA's expected returns ?

Yes

syndicate

a group of business people working together

Assume a stock experiences an actual return that is above the security market line. An analyst can safely conclude that the stock has:

a higher return than expected for the level of risk assumed.

how do you get deviations for returns?

actual return- avg return (aka arithmetic avg)

With Dutch auction underwriting:

all successful bidders pay the same price per share

Green Shoe Provision

allows the investment banker the right to purchase up to 15% of additional shares over a thirty-day period beyond that offered to the public during the auction maintain inventory and fill any pent-up demand.

tombstone

an advertisement of a financial newspaper announcing the PO of securities along with the list of the investment banks that is handling the offering

asset risk premium

beta * market risk premium

A ________ is the market's measure of systematic risk.

beta of one

CAPM depends on

beta, market risk premium, risk free rate

For the period 2009-2019, U.S. Treasury bills had an annual rate of return that was:

between 0 and 2.5 percent.

The ________ explains the relationship between the expected return on a security and the level of that security's systematic risk.

capital asset pricing model

what is the total dollar return?

capital gain + dividend or capital gain + coupon

whats capital gain yield ?

capital gain / initial price

what is the capital gains yield formula?

capital gains / initial price

which of the following stocks can be negative? dividend yield, capital gains yield, total return

capital gains yield and total return

How do you get dividend per share with capital loss per share and total loss per share

capital loss per share - total loss per share

How do you get capital gain ?

change in price

Ignoring taxes, at the break-even point between a levered and an unlevered capital structure, the:

company is earning just enough to pay for the cost of the debt.

correlation

covariance of a and b / (standard deviation a + standard deviation b)

When a firm announces an upcoming seasoned stock offering, the market price of the firm's existing shares tends to:

decrease.

Assume a firm has a debt-equity ratio of .48. The firm's cost of equity is:

directly related to the risk level of the firm.

dividend yield

dividends per share/ initial market price per share

Vu formula

ebit*(1-Tc) / unlevered cost of firm

While evaluating a stock, you estimate that it will earn a return of 11 percent if economic conditions are favorable, and 3 percent if economic conditions are unfavorable. Given the probabilities of favorable versus unfavorable economic conditions, you conclude that the stock will earn 7.2 percent next year. The 7.2 percent figure is called the:

expected return

T/F : Consumer claims will generally have the highest priority when assets are distributed in a bankruptcy proceeding.

false

True or False: Individual investors who continually monitor the financial markets seeking mispriced securities are always quite successful using only historical price information as their basis of evaluation.

false

True or False: Individual investors who continually monitor the financial markets seeking mispriced securities are overwhelmingly successful in earning abnormal profits.

false

True or False: real asset markets are more efficient than financial markets

false

True or false: Individual investors who continually monitor the financial markets seeking mispriced securities earn excess profits on all of their investments.

false

t/f : Dividend payment to preferred shareholders will generally have the highest priority when assets are distributed in a bankruptcy proceeding.

false

True or False: the capital gains yield can only be positive or zero.

false the capital gains yield can be negative which means there is a capital loss

Pecking Order Theory

firms prefer to issue debt rather than equity if internal finance is insufficient

The average compound return earned per year over a multiyear period is called the _____ average return.

geometric

A syndicate can best be defined as a:

group of underwriters sharing the risk of selling a new issue of securities.

To convince investors to accept greater volatility, you must:

increase risk premium

Assume a firm utilizes its WACC as the discount rate for every capital project it implements. Accordingly, the firm will tend to:

increase the average risk level of the company over time.

buying price

investment/ underwritter buys

The business risk of a company:

is positively related to the company's cost of equity.

index funds are not ______

managed

Assume a firm has a debt-equity ratio of .62. The firm's weighted average cost of capital is the:

rate of return a company must earn on its existing assets to maintain the current value of its stock.

A preliminary prospectus is sometimes called a:

red herring.

When an issuer offers new securities to the general public, it must file a(n) ________ with the SEC to disclose all material information about the issuer.

registration statement

If the market is efficient and securities are priced fairly, all securities will have the same:

reward-to-risk ratio.

according to mm prop 2 the risk of equity...

rises with the leverage

Unsystematic risk definition

risk that is unique to a company or industry. made of business risk and financial risk (capital structure)

The security market line intercepts the vertical axis at the:

risk-free rate.

For any given capital project proposal, the discount rate should be based on the:

risks associated with the use of the funds required by the project.

What is the capital gains formula?

selling price - initial price

Which category of securities had the most volatile annual returns over the period 1926-2019?

small-company stocks

Which security earned the highest risk premium over the period 1926-2019?

small-company stocks

How do you get standard deviation?

square root _/^^^^^of variance

To purchase a share in a rights offering, an existing shareholder generally just needs to:

submit the required number of rights along with the subscription price.

What is the variance formula?

sum of standard deviations / (# of the years -1)

Does the capital gains yield only include realized gains?

the capital gains yield can have realized and unrealized gains

The interest tax shield is a key reason why:

the net cost of debt is generally less than the cost of equity.

how you get nominal rate ?

total dollar return / initial price

Estimates of the rate of return on a security based on the historical geometric average will probably tend to _____ the expected return for the short-term.

underestimate

With the exception of a few industries, most corporations in the U.S. tend to:

underutilize debt.

An unexpected post on social media caused the prices of 22 different companies' stocks to immediately increase by 10 to 15 percent. This occurrence is best described as an example of ________ risk.

unsystematic

If a company has the optimal amount of debt, then the:

value of the levered company will exceed the value of the unlevered company.

volatility is the _________ of total stock's return

variance standard deviation

M&M Proposition I with tax implies that the:

weighted average cost of capital decreases as the debt-equity ratio increases.

The value of a firm is maximized when the:

weighted average cost of capital is minimized.

offering price

what the public buys

when is the capital gains yield positive?

when the selling price is higher than the purchase price

Last year, you purchased 500 shares of Ayala, Incorporated, stock for $25.20 per share. You have received a total of $400 in dividends and $17,000 in proceeds from selling the shares. What is your capital gains yield on this stock?

34.9% 1. Get initial price: 500*25.50=12,600 2.Get Capital Gains: 17,000-12600) =4,400 3. Get capital gains yield: 4,400/12,600= .3492

It is common for venture capitalists to receive at least ___ percent of a start-up company's equity in exchange for the venture capital.

40

For the period 1926-2019, the average risk premium on large-company stocks was about:

8.7 percent

Which of the following statements is true of a portfolio's standard deviation?

It can be less than the standard deviation of the least risky security in the portfolio.

Which of the following statements regarding the cost of preferred stock is accurate?It equals the dividend yield. ) it equals the dividend yield ) It equals the yield to maturity. ) It is highly dependent on the dividend growth rate. ) It is independent of the preferred stock's price. ) It decreases when tax rates increase.

It equals the dividend yield.

With respect to capital project analysis, which of the following statements is accurate? ) The subjective approach assigns a discount rate to each project based on other companies in the same category as the project. ) 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. ) Companies will correctly accept or reject every project if they adopt the subjective approach. ) Mandatory projects should only be accepted if they produce a positive NPV when the overall company WACC is used as the discount rate. ) The pure play approach should only be used with low-risk projects.

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.

Which form of market efficiency would most likely offer the greatest profit potential to an outstanding professional stock analyst?

Weak

When do you not use WACC

When beta is diff from firm

Individual investors might avoid requesting 100 shares in an upcoming IPO because they:

are more apt to receive shares if the IPO is under allocated.

t/f: Payment to an unsecured creditor will generally have the highest priority when assets are distributed in a bankruptcy proceeding.

false

The difference between the underwriters' cost of buying shares in a firm commitment and the offering price of those securities to the public is called the:

gross spread.

Assume the market rate of return is 10.1 percent and the risk-free rate of return is 3.2 percent. Lexant stock has 2 percent less systematic risk than the market and has an actual return of 10.2 percent. This stock:

is underpriced.

A company is technically insolvent when:

it is unable to meet its financial obligations.

With firm commitment underwriting, the issuing firm:

knows upfront the amount of money it will receive from the stock offering.

A company that has a(n) ________ would be most likely to have a high percentage of debt in its optimal capital structure.

low probability of financial distress

Individual investors who continually monitor the financial markets seeking mispriced securities:

make the markets increasingly more efficient.

The value of a right depends upon the number of rights required for each new share as well as the:

market and subscription prices.

When calculating the expected rate of return on a stock portfolio using a weighted average, the weights are based on the:

market value of the investment in each stock.

A firm should select the capital structure that:

maximizes the value of the firm.

Existing shareholders:

may or may not have a pre-emptive right to newly issued shares.

if the chief financial officer of Company DA unexpectedly resigned. Would this be reflected in Company DA's expected returns ?

no it would not

Estimates of the rate of return on a security based on the historical arithmetic average will probably tend to _____the expected return for the long-term

overestimate

If a poorly-diversified portfolio becomes well diversified, we would expect the portfolio's:

standard deviation to decrease

Inside information has the least value when financial markets are:

strong form efficient.