FINA 3770 Midterm 3

Beta is a measurement of the relationship between a security's returns and the general market's returns.

True

Beta represents the average movement of a company's stock returns in response to a movement in the market's returns.

True

Bondholders and preferred stockholders can be viewed as creditors, whereas the common stockholders are the true owners of the firm.

True

Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities.

True

Diversifying among different kinds of assets is called asset allocation.

True

The required rate of return for an asset is equal to the risk-free rate plus a risk premium.

True

Total risk equals systematic risk plus unsystematic risk.

True

The Beta of a T-bill is zero.

True, T-Bills do not correlate with the stock market

Common stock does not mature.

True

A typical measure for the risk-free rate of return is the A) U.S. Treasury Bill rate. B) prime lending rate. C) money market rate. D) short-term AAA-rated bond rate.

A) U.S. Treasury Bill rate.

Stock A has a beta of 1.2 and a standard deviation of returns of 18%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the market risk premium increases, then A) the required return on stock B will increase more than the required return on stock A. B) the required returns on stocks A and B will both increase by the same amount. C) the required returns on stocks A and B will remain the same. D) the required return on stock A will increase more than the required return on stock B.

A) the required return on stock B will increase more than the required return on stock A.

Most preferred stocks have a feature that requires all past unpaid preferred dividend payments be paid before any common stock dividends can be paid. What is the name of this feature? A) participating B) cumulative C) provisional D) convertible

B) cumulative

Preferred stock valuation usually treats the preferred stock as a A) capital asset. B) perpetuity. C) common stock. D) long-term bond.

B) perpetuity.

What is the name given to the equation that financial managers use to measure an investor's required rate of return? A) the standard deviation B) the capital asset pricing model C) the coefficient of variation D) the MIRR

B) the capital asset pricing model

Nogrowth Corporation expects their dividend to stay at $0.50 per share each year into the foreseeable future. Therefore A) the stock will be valued at $0.50 times the number of years an investor plans to keep it. B) the value of the stock can be estimated as $0.50 divided by an investor's required rate of return. C) the value of the stock cannot be determined using the dividend valuation model because the growth rate is zero. D) the value of the stock is positive only if the required return is negative

B) the value of the stock can be estimated as $0.50 divided by an investor's required rate of return.

Most stocks have betas between A) -1.00 and 1.00. B) 0.00 and 1.00. C) 0.60 and 1.60. D) 1.00 and 2.00.

C) 0.60 and 1.60.

Portfolio risk is typically measured by ________ while the risk of a single investment is measured by ________. A) standard deviation; beta B) security market line; standard deviation C) beta; standard deviation D) beta; slope of the characteristic line

C) beta; standard deviation

The minimum rate of return necessary to attract an investor to purchase or hold a security is referred to as the A) stock's beta. B) investor's risk premium. C) investor's required rate of return. D) risk-free rate.

C) investor's required rate of return.

Which of the following features, or benefits, belong to a firm's common stockholders? A) limited liability B) ownership of the firm C) voting rights D) all of the above

D) all of the above

Which of the following investments is clearly preferred to the others for a risk-averse investor? Investment return σ A 14% 12% B 22% 20% C 18% 16% A) Investment A B) Investment B C) Investment C D) cannot be determined without additional information

D) cannot be determined without additional information

Beta is a statistical measure of A) unsystematic risk. B) total risk. C) the standard deviation. D) the relationship between an investment's returns and the market return.

D) the relationship between an investment's returns and the market return.

Beginning with an investment in one company's securities, as we add securities of other companies to our portfolio, which type of risk declines? A) systematic risk B) market risk C) non-diversifiable risk D) unsystematic risk

D) unsystematic risk

ABC Corp 5% preferred stock with a par value of $100 and a market price of $125 will pay an annual dividend this year of $12 per share.

False, PMT = 0.05 * 100 = 5

Actual returns are always less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value.

False, actual returns could be less or more

Preferred stock and common stock issued by the same firm will have the same required return because the riskiness of the firm's cash flows is the same for both securities

False, common stock is riskier, so it should have a higher required rate of return

If a firm does not have enough money to pay any common stock dividends, it is technically in default to the common shareholders.

False, dividends are optional

Asset allocation is not recommended by financial planners because mixing different types of assets, such as stocks with bonds, makes it more difficult to track performance and adjust portfolios to changing market conditions.

False, mixing different types of assets increases diversification

You are considering buying some stock in Continental Grain. Which of the following are examples of non-diversifiable risks? I. Risk resulting from a general decline in the stock market. II. Risk resulting from a possible increase in income taxes. III. Risk resulting from an explosion in a grain elevator owned by Continental. IV. Risk resulting from a pending lawsuit against Continental.

I and II

A preferred stock that pays an annual dividend of $10, has a par value of $100, and has a required return of 5% will be valued at $200.

T, Vps = 10/0.05 = 200

A stock with a beta of 1 has systematic or market risk equal to the "typical" stock in the marketplace.

True

According to the CAPM, for each unit of Beta an asset's required rate of return increases by the market's risk premium.

True

In general, common stock and preferred stock are both valued by calculating the present value of all expected future cash flows, using the required return as the discount rate.

True

In terms of risk, preferred stock is safer than common stock because it has a prior claim on assets and income.

True

In theory, shareholders select the board of directors, but in reality, management effectively selects the directors.

True

Preferred stock is less risky than common stock, but more risky than debt

True

Preferred stock is referred to as a hybrid security because it has many characteristics of both common stock and bonds.

True

Preferred stock is riskier than long-term debt because its claim on assets and income come after those of bonds.

True

The amount of the preferred stock dividend is generally fixed either as a dollar amount or as a percentage of the par value.

True

The benefits of diversification occur as long as the investments in a portfolio are not perfectly positively correlated.

True