Finance Final Exam (Terms and Concepts)

When attempting to forecast for extremely long intervals, such as 50 years, it is best to use: A. Geometric Averages B. Arithmetic Averages C. Expected Return Averages D. Forecasting Averages E. Long Range Modeling Averages

A. Geometric Averages

Which of the following statements are accurate? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable risk. IV. Diversifiable risks are market risks you cannot avoid. A. I and III only B. II and IV only C. I and II only D. III and IV only E. I, II, and III only

A. I and III only

Of the options listed below, which is the best example of systematic risk? A. Investors panic causing security prices around the globe to fall precipitously. B. A flood washes away a firm's warehouse. C. A city imposes an additional one percent sales tax on all products. D. A toymaker has to recall its top-selling toy. E. Corn prices increase due to increased demand for alternative fuels.

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

Which of the following statements regarding unsystematic risk is accurate? A. It can be effectively eliminated by portfolio diversification. B. It is compensated for by the risk premium. C. It is measured by beta. D. It is measured by standard deviation. E. It is related to the overall economy.

A. It can be effectively eliminated by portfolio diversification.

Which of the following statements regarding a firm's pretax cost of debt is accurate? A. It is based on the current yield to maturity of the company's outstanding bonds. B. It is equal to the coupon rate on the latest bonds issued by the company. C. It is equivalent to the average current yield on all of a company's outstanding bonds. D. It is based on the original yield to maturity on the latest bonds issued by a company. E. It must be estimated as it cannot be directly observed in the market.

A. It is based on the current yield to maturity of the company's outstanding bonds.

An investor wants to reduce the unsystematic risk in her portfolio. Which of the following actions is least likely to do so? A. Reducing the number of stocks held in her stock portfolio B. Adding bonds to her stock portfolio C. Adding international securities into her portfolio of U.S. stocks D. Adding U.S. Treasury bills to her risky portfolio E. Adding technology stocks to her portfolio of industrial stocks

A. Reducing the number of stocks held in her stock portfolio

Assume that last year T-bills returned 2.2 percent while your investment in large-company stocks earned an average of 8.1 percent. Which one of the following terms refers to the difference between these two rates of return? A. Risk premium B. Geometric average return C. Arithmetic average return D. Standard deviation E. Variance

A. Risk premium

The Capital Asset Pricing Model (CAPM) shows that the expected return for a particular asset depends on all of the following, except: A. The return on a risk-less asset B. The pure time value of money C. The reward for bearing systematic risk D. The amount of systematic risk

A. The return on a risk-less asset

Which form of market efficiency would most likely offer the greatest profit potential to an outstanding professional stock analyst? A. Weak B. Semiweak C. Semistrong D. Strong E. Perfect

A. Weak

Portfolio Beta is the ______________ average of the Betas of the investments included in the portfolio. A. Weighted B. Arithmetic C. Geometric D. Riskless E. Expected

A. Weighted

What is the subjective approach? A. Using a WACC that offers room to play with the rates as needed. B. Using a WACC that involves making subjective adjustments based upon the project. C. Using a WACC that allows subjective adjustments to the revenue for the project. D. Using a WACC that adjusts to market interest rates. E. Using a WACC that is based on companies in similar lines of business.

B. Using a WACC that involves making subjective adjustments based upon the project.

Standard deviation is a measure of which one of the following? A. Average rate of return B. Volatility C. Probability D. Risk premium E. Real returns

B. Volatility

When calculating a firm's weighted average cost of capital, the capital structure weights: A. are based on the book values of debt and equity. B. are based on the market values of the outstanding securities. C. depend upon the financing obtained to fund each specific project. D. remain constant over time unless new securities are issued or outstanding securities are redeemed. E.are restricted to debt and common stock.

B. are based on the market values of the outstanding securities.

Okonjo Economics has a debt-equity ratio of .38. All of the firm's outstanding shares were purchased by a small number of investors. The return these investors require is called the: A. dividend yield. B. cost of equity. C. capital gains yield. D. cost of capital. E. income return.

B. cost of equity.

A firm's aftertax cost of debt will increase if there is a(n): A. decrease in the company's debt-equity ratio. B. decrease in the company's tax rate. C. increase in the credit rating of the company's bonds. D. increase in the company's beta. E. decrease in the market rate of interest.

B. decrease in the company's tax rate.

To convince investors to accept greater volatility, you must: A. decrease the risk premium. B. increase the risk premium. C. decrease the real return. D. decrease the risk-free rate. E. increase the risk-free rate.

B. increase the risk premium

Individual investors who continually monitor the financial markets seeking mispriced securities: A. earn excess profits on all of their investments. B. make the markets increasingly more efficient. C. are never able to find a security that is temporarily mispriced. D. are overwhelmingly successful in earning abnormal profits. E. are always quite successful using only historical price information as their basis of evaluation.

B. make the markets increasingly more efficient.

According to the capital asset pricing model (CAPM), the amount of reward an investor receives for bearing the risk of an individual security depends upon the: A. amount of total risk assumed and the market risk premium. B. market risk premium and the amount of systematic risk inherent in the security. C. risk-free rate, the market rate of return, and the standard deviation of the security. D. beta of the security and the market rate of return. E. standard deviation of the security and the risk-free rate of return.

B. market risk premium and the amount of systematic risk inherent in the security.

Rafia owns stocks of 15 different companies. Together, the stocks have a value of $78,640. Twelve percent of that total value is from one company, Gambrell & Valdez. The twelve percent figure is called a(n): A. portfolio return. B. portfolio weight. C. degree of risk. D. price-earnings ratio. E. index value.

B. portfolio weight.

Buchi owns several financial instruments: stocks issued by seven different companies, plus bonds issued by four different companies. Her investments are best described as a(n): A. index. B. portfolio. C. collection. D. grouping. E. risk-free position.

B. portfolio.

Assume a manager determines the cost of capital for a specific project based on the cost of capital at another firm with a line of business that is similar to the project. Accordingly, the manager is using the ________ approach. A. subjective risk B. pure play C. divisional cost of capital D. capital adjustment E. security market line

B. pure play

To calculate the expected risk premium on a stock, one must subtract the ________ from the stock's expected return. A. expected market rate of return B. risk-free rate C. inflation rate D. standard deviation E. variance

B. risk-free rate

Expected return is the return on a _______ asset expected in the future. A. average B. risky C. no-risk D. risk-free E. portfolio

B. risky

An investor who owns a well-diversified portfolio would consider ________ to be irrelevant. A. systematic risk B. unsystematic risk C. market risk D. nondiversifiable risk E. the systematic portion of a surprise

B. unsystematic risk

Which of the following statements regarding the weighted average cost of capital is accurate? A. It equals the aftertax cost of the outstanding liabilities. B. It should be used as the required return when analyzing any new project. C. It is the return investors require on the total assets of the firm. D. It remains constant when the debt-equity ratio changes. E. It is unaffected by changes in corporate tax rates.

C. It is the return investors require on the total assets of the firm.

For the Dividend Growth Model, the equation can be written as follows: P0 = =D1/(RE - g). How can this equation be rearranged? A. RE = D1/g + P0 B. RE = D1 * P0 + g C. RE = D1/P0 + g D. RE = g /P0 + D1 E. RE = P0/D1 + g

C. RE = D1/P0 + g

Which one of the following earned the highest risk premium over the period 1926-2019? A.Long-term corporate bonds B. U.S. Treasury bills C. Small-company stocks D. Large-company stocks E. Long-term government bonds

C. Small-company stocks

A firm's target capital structure represents: A. the cost of equity to achieve the desired NPV. B. the cost of debt to achieve the desired NPV. C. a fixed debt-equity ratio that the company attempts to maintain. D. a fixed cost of capital that the company maintains. E. the required return for the project with the highest NPV.

C. a fixed debt-equity ratio that the company attempts to maintain.

Wright Market Research is able to borrow money at a rate of 6.8 percent per year. This interest rate is called the: A. compound rate. B. current yield. C. cost of debt. D. capital gains yield. E. cost of capital.

C. cost of debt.

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: A. arithmetic return. B. historical return. C. expected return. D. geometric return. E. required return.

C. expected return.

When calculating the expected rate of return on a stock portfolio using a weighted average, the weights are based on the: A. number of shares owned of each stock. B. market price per share of each stock. C. market value of the investment in each stock. D. original amount invested in each stock. E. cost per share of each stock held.

C. market value of the investment in each stock.

You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor often comments on the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient. A. weak B. semiweak C. semistrong D. strong E. perfect

C. semistrong

Of the options listed below, which is the best example of a diversifiable risk? A. Interest rates increase B. Energy costs increase C. Core inflation increases D. A firm's sales decrease E. Federal income taxes increase

D. A firm's sales decrease

________ measures total risk, and ________ measures systematic risk. A. Beta; alpha B. Beta; standard deviation C. Alpha; beta D. Standard deviation; beta E. Standard deviation; variance

D. Standard deviation; beta

Vanessa purchased a stock one year ago and sold it today for $3.15 per share more than her purchase price. She received a total of $2.60 per share in dividends. Which one of the following statements is correct in relation to this investment? A. The dividend yield is expressed as a percentage of the par value. B. The capital gain would have been less had Vanessa not received the dividends. C. The total dollar return per share is $.55. D. The capital gains yield is positive. E. The dividend yield is greater than the capital gains yield.

D. The capital gains yield is positive.

When using economic probabilities to compute the expected return on a stock, the result is: A. guaranteed to equal the actual average return on the stock for the next five years. B. guaranteed to be the minimal rate of return on the stock over the next two years. C. guaranteed to equal the actual return for the immediate twelve month period. D. a mathematical expectation based on a weighted average and not a guaranteed outcome. E. the actual return you should anticipate as long as the economic forecast remains constant.

D. a mathematical expectation based on a weighted average and not a guaranteed outcome.

The percent of investment that the project costs can be referred to as all of the following, except: A. required return B. appropriate discount rate C. cost of money D. free cash flow E. cost of capital

D. free cash flow

The average compound return earned per year over a multiyear period is called the _____ average return. A. arithmetic B. standard C. variant D. geometric E. real

D. geometric

The market risk premium equals the: A. risk-free rate of return plus the inflation rate. B. risk-free rate of return plus the market rate of return. C. inflation rate minus the risk-free rate of return. D. market rate of return minus the risk-free rate of return. E. risk-free rate of return multiplied by the market beta.

D. market rate of return minus the risk-free rate of return.

The cost of preferred stock is equivalent to the: A. pretax cost of debt. B. rate of return on an annuity. C. aftertax cost of debt. D. rate of return on a perpetuity. E. cost of an irregular growth common stock.

D. rate of return on a perpetuity.

Inside information has the least value when financial markets are: A. weak form efficient. B. semiweak form efficient. C. semistrong form efficient. D. strong form efficient. E. inefficient.

D. strong form efficient.

To determine a firm's cost of capital, one must include: A. only the return required by the firm's current shareholders. B. only the current market rate of return on equity shares. C. the weighted costs of all future funding sources. D. the returns currently required by both debtholders and stockholders. E. the company's original debt-equity ratio.

D. the returns currently required by both debtholders and stockholders.

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. A. portfolio B. nondiversifiable C. market D. unsystematic E. expected

D. unsystematic

The security market line is a positively sloped straight line that displays the relationship between expected return and ____________. A. WACC B. Risk C. Portfolio D. Market Risk Premium E. Beta

E. Beta

Assume all stock prices fairly reflect all of the available information on those stocks. Which one of the following terms best defines the stock market under these conditions? A. Riskless market B. Evenly distributed market C. Zero volatility market D. Blume's market E. Efficient capital market

E. Efficient capital market

Which of the following items are included when calculating the expected return on a portfolio? I. Percentage of the portfolio invested in each individual security II. Projected states of the economy III. The performance of each security given various economic states IV. Probability of occurrence for each state of the economy A. I and III only B. II and IV only C. I, III, and IV only D. II, III, and IV only E. I, II, III, and IV

E. I, II, III, and IV

Which one of the following statements related to market efficiency tends to be supported by current evidence? A. It is easy for investors to earn abnormal returns. B. Short-run price movements are easy to predict. C. Markets are most likely only weak form efficient. D. Mispriced stocks are easy to identify. E. Markets tend to respond quickly to new information.

E. Markets tend to respond quickly to new information.

Which of the following statements best describes the principle of diversification? A. Concentrating an investment in two or three stocks will eliminate all of the unsystematic risk. B. Concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. C. Spreading an investment across multiple diverse companies will not lower the total risk. D. Spreading an investment across many diverse assets will eliminate all of the systematic risk. E. Spreading an investment across many diverse assets will eliminate some of the total risk.

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

Which one of the following is the most likely reason why a stock price might not react at all on the day that new information related to the stock's issuer is released? Assume the market is semistrong form efficient. A. Company insiders were aware of the information prior to the announcement. B. Investors do not pay attention to daily news. C. Investors tend to overreact. D. The news was positive. E. The information was expected.

E. The information was expected.

Which of the following is the main advantage of using the dividend growth model to estimate a firm's cost of equity? A. The ability to apply either current or future tax rates. B. The model's applicability to all corporations. C. The model's consideration of risk. D. The stability of the computed cost of equity over time. E. The simplicity of the model.

E. The simplicity of the model.

What is the pure play approach? A. Using a WACC that offers room to play with the rates as needed. B. Using a WACC that involves making subjective adjustments based upon the project. C. Using a WACC that allows subjective adjustments to the revenue for the project. D. Using a WACC that adjusts to market interest rates. E. Using a WACC that is based on companies in similar lines of business.

E. Using a WACC that is based on companies in similar lines of business.

When evaluating any capital project proposal, the cost of capital: A. is determined by the overall risk level of the firm. B. is dependent upon the source of the funds obtained to fund that project. C. is dependent upon the firm's overall capital structure. D. should be applied as the discount rate for all other projects considered by the firm. E. depends upon how the funds raised for that project are going to be spent.

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

The required return of preferred stock is equal to the ________ ________ on the preferred stock. A. fixed dividend B. current price C. bond rating D. perpetuity rating E. dividend yield

E. dividend yield

For any given capital project proposal, the discount rate should be based on the: A. company's overall weighted average cost of capital. B. actual sources of funding used for the project. C. average of the company's overall cost of capital for the past five years. D. current risk level of the overall firm. E. risks associated with the use of the funds required by the project.

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

If a poorly-diversified portfolio becomes well diversified, we would expect the portfolio's: A. beta to increase. B. beta to decrease. C. rate of return to increase. D. standard deviation to increase. E. standard deviation to decrease.

E. standard deviation to decrease.

Flotation costs should be included in the calculation of the Weighted Average Cost of Capital (WACC). True False

False

The arithmetic average tells you what you actually earned per year on average, whereas the geometric average tells you what you earned in a typical year. True False

False

The cost of capital depends primarily on the source of the funds, not the use. True False

False

The coupon rate on the firm's outstanding debt can be used as a substitute for the cost of debt. True False

False

Risk-free assets have a beta of 0 and the market portfolio has a beta of 1. True False

True

Since preferred stock has a fixed dividend paid every period forever, it is essentially a perpetuity. True False

True