Fin 300 - Exam 3 Concept Questions

A stock with an actual return that lies above the security market line has: A. More systematic risk than the overall market. B. More risk than that warranted by CAPM. C. A higher return than expected for the level of risk assumed. D. Less systematic risk than the overall market. E. A return equivalent to the level of risk assumed.

C

In actual practice, managers most frequently use which two types of investment criteria? A. NPV and payback. B. AAR and IRR. C. IRR and NPV. D. IRR and payback. E. NPV and PI.

C

Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be? A. Accept both projects because both NPVs are positive. B. Accept Project A because it has the shortest payback period. C. Accept Project B and reject Project A based on the NPVs. D. Accept Project A and reject Project B based on their AARs. E. Accept Project A because it has the lower required return.

C

Small-company stocks, as the term is used in the textbook, are best defined as the: A. 500 newest corporations in the U.S. B. Firms whose stock trades otc. C. Smallest twenty percent of the firms listed on the NYSE. D. Smallest twenty-five percent of the firms listed on NASDAQ. E. Firms whose stock is listed on NASDAQ.

C

Which of the following are advantages of the payback method of project analysis? A. Considers time value of money, liquidity bias. B. Liquidity bias, arbitrary cutoff point. C. Liquidity bias, ease of use. D. Ignores time value of money, ease of use. E. Ease of use, arbitrary cutoff point.

C

Which one of the following statements related to the internal rate of return (IRR) is correct? A. The IRR yields the same accept and reject decisions as the net present value method given mutually exclusive projects. B. A project with an IRR equal to the required return would reduce the value of a firm if accepted. C. The IRR is equal to the required return when the net present value is equal to zero. D. Financing type projects should be accepted if the IRR exceeds the required return. E. The average accounting return is a better method of analysis than the IRR from a financial point of view.

C

Which two methods of project analysis are the most biased towards short-term projects? A. Net present value and internal rate of return. B. Internal rate of return and profitability index. C. Payback and discounted payback. D. Net present value and discounted payback. E. Discounted payback and profitability index.

C

Last year, T-bills returned 2 percent while your investment in large-company stocks earned an average of 5 percent. Which one of the following terms refers to the difference between these two rates of return? A. Risk premium B. Geometric return C. Arithmetic D. Standard deviation E. Variance

A

Net present value: A. Is the best method of analyzing mutually exclusive projects. B. Is less useful than the internal rate of return when comparing different sized projects. C. Is the easiest method of evaluation for nonfinancial managers to use. D. Cannot be applied when comparing mutually exclusive projects. E. Is very similar in its methodology to the average accounting return.

A

The intercept point of the security market line is the rate of return which corresponds to: A. The risk-free rate. B. The market rate. C. A return of zero. D. A return of 1.0 percent. E. The market risk premium.

A

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock: A. Is underpriced. B. Is correctly priced. C. Will plot below the security market line. D. Will plot on the security market line. E. Will plot to the right of the overall market on a security market line graph.

A

The return earned in an average year over a multiyear period is called the _____ average return. A. Arithmetic B. Standard C. Variant D. Geometric E. Real

A

Unsystematic risk: A. Can be effectively eliminated by portfolio diversification. B. Is compensated for by the risk premium. C. Is measured by beta. D. Is measured by standard deviation. E. Is related to the overall economy.

A

Which of the following statements concerning risk are correct? I.Non diversifiable risk is measured by beta. II.The risk premium increases as diversifiable risk increases. III.Systematic risk is another name for non diversifiable 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

Which one of the following is an advantage of the average accounting return method of analysis? A. Easy availability of information needed for the computation. B. Conclusion of time value of money considerations. C. The use of a cutoff rate as a benchmark. D. The use of pre-tax income in the computation. E. Use of real, versus nominal, average income.

A

Which one of the following is an 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

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? A. Capital asset pricing model B. Time value of money equation C. Unsystematic risk equation D. Market performance equation E. Expected risk formula

A

You are viewing a graph that plots the NPVs of a project to various discount rates that could be applied to the project's cash flows. What is the name given to this graph? A. Project tract. B. Projected risk profile. C. NPV profile. D. NPV route. E. Present value sequence.

C

Inside information has the least value when financial markets are: A. Weak form efficient. B. Semi weak form efficient. C. Semi strong form efficient. D. Strong form efficient. E. Inefficient.

D

The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient. A. Weak B. Semi weak C.Semi strong D. Strong E. Perfect

D

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. A Real return B. Actual return C. Nominal return D. Risk premium E. Expected return

D

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

The cost of preferred stock is computed the same as the: A. Pre-tax 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

The internal rate of return is defined as the: A. Maximum rate of return a firm expects to earn on a project. B. Rate of return a project will generate if the project in financed solely with internal funds. C. Discount rate that equates the net cash inflows of a project to zero. D. Discount rate which causes the net present value of a project to equal zero. E. Discount rate that causes the profitability index for a project to equal zero.

D

The profitability index is most closely related to which one of the following? A. Payback. B. Discounted payback. C. Average accounting return. D. Net present value. E. Modified internal rate of return.

D

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that: A. Stock A is riskier than stock B and both stocks are fairly priced. B. Stock A is less risky than stock B and both stocks are fairly priced. C. Either stock A is underpriced or stock B is overpriced or both. D. stock A is overpriced or stock B is underpriced or both. E. Both stock A and stock B are correctly priced since stock A is riskier than stock B.

D

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas? A. Reward-to-risk matrix B. Portfolio weight graph C. Normal distribution D. Security market line E. Market real returns

D

Which one of the following statements is correct concerning market efficiency? A. Real asset markets are more efficient than financial markets. B. If a market is efficient, arbitrage opportunities should be common. C. In an efficient market, some market participants will have an advantage over others. D. A firm will generally receive a fair price when it issues new shares of stock if the market is efficient. E. New information will gradually be reflected in a stock's price to avoid any sudden change in the price of the stock if the market is efficient.

D

Which one of the following will decrease the net present value of a project? A. Increasing the value of each of the project's discounted cash inflows. B. Moving each of the cash inflows forward to a sooner time period. C. Decreasing the required discount rate. D. Increasing the project's initial cost at time zero. E. Increasing the amount of the final cash inflow.

D

A project has a net present value of zero. Which one of the following best describes this project? A. The project has a zero percent rate of return. B. The project requires no initial cash investment. C. The project has no cash flows. D. The summation of all of the project's cash flows is zero. E. The project's cash inflows equal its cash outflows in current dollar terms.

E

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

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 semi strong 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

Which one of the following statements related to unexpected returns is correct? A. All announcements by a firm affect that firm's unexpected returns. B. Unexpected returns over time have a negative effect on the total return of a firm. C. Unexpected returns are relatively predictable in the short-term. D. Unexpected returns generally cause the actual return to vary significantly from the expected return over the long-term. E. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

E

Efficient financial markets fluctuate continuously because: A. The markets are continually reacting to old information as that information is absorbed. B. The markets are continually reacting to new information. C. Arbitrage trading is limited. D. Current trading systems require human intervention. E. Investments produce varying levels of net present values.

B

If a project has a net present value equal to zero, then: A. The total of the cash inflows must equal the initial cost of the project. B. The project earns a return exactly equal to the discount rate. C. A decrease in the project's initial cost will cause the project to have a negative NPV. D. Any delay in receiving the projected cash inflows will cause the project to have a positive NPV. E. The project's PI must also be equal to zero.

B

The dividend growth model cannot be used to compute the cost of equity for a firm that: A. Pays an increasing dividend. B. Reduces its dividend on a regular basis. C. Has a dividend payout ratio of 100 percent. D. Pays a constant dividend year after year. E. Has a retention ratio of 100 percent.

E

The standard deviation of a portfolio: A. Is a measure of that portfolio's systematic risk. B. Is a weighted average of the standard deviations of the individual securities held in that portfolio. C. Measures the amount of diversifiable risk inherent in the portfolio. D. Serves as the basis for computing the appropriate risk premium for that portfolio. E. Can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

E

The weighted average cost of capital for a firm can depend on all of the following except the: A. Firm's beta. B. Coupon rate of the outstanding bonds. C. Growth rate of the firm's dividends. D. Firm's marginal tax rate. E. Standard deviation of the firm's common stock.

E

Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the: A. Average arithmetic return. B. Expected return. C. Market rate of return. D. Internal rate of return. E. Cost of capital.

E

Which one of the following correctly applies to the average accounting rate of return? A. It considers the time value of money. B. It measures net income as a percentage of the sales generated by a project. C. It is the best method of analyzing mutually exclusive projects from a financial point of view. D. It is the primary methodology used in analyzing independent projects. E. It can be compared to the return on assets ratio.

E

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

E