Finance 3

Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines. Kate is applying the ___ approach. pure play divisional rating subjective straight WACC equity rating

subjective

For a risky security to have a positive expected return but less risk than the overall market, the security must have a beta: of zero. that is > 0 but < 1. of one. that is > 1. that is infinite.

that is > 0 but < 1.

Standard deviation measures _____ risk while beta measures _____ risk. systematic; unsystematic unsystematic; systematic total; unsystematic total; systematic asset-specific; market

total; systematic

The standard deviation measures the _____ of a security's returns over time. average value frequency volatility mean arithmetic average

volatility

Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion? Another brick-and-mortar store that also sells online A wholesale toy distributor A toy store that sells online only The oldest online retailer of any product Derek's own store

A toy store that sells online only

Which one of the following is the best example of unsystematic risk? Inflation exceeding market expectations A warehouse fire Decrease in corporate tax rates Decrease in the value of the dollar Increase in consumer spending

A warehouse fire

An efficient capital market is best defined as a market in which security prices reflect which one of the following? Current inflation A risk premium All available information The historical arithmetic rate of return The historical geometric rate of return

All available information

Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the return that Katie and the other shareholders require on their investment in ABC? Weighted average cost of capital Pure play cost Cost of equity Subjective cost Cost of debt

Cost of equity

Which one of these is the best example of systematic risk? Discovery of a major gas field Decrease in textile imports Increase in agricultural exports Decrease in gross domestic product Decrease in management bonuses for banking executives

Decrease in gross domestic product

Which one of the following is defined as the average compound return earned per year over a multiyear period? Geometric average return Variance of returns Standard deviation of returns Arithmetic average return Normal distribution of returns

Geometric average return

Which one of these represents systematic risk? Major layoff by a regional manufacturer of power boats Increase in consumption created by a reduction in personal tax rates Surprise firing of a firm's chief financial officer Closure of a major retail chain of stores Product recall by one manufacturer

Increase in consumption created by a reduction in personal tax rates

Which one of the following will increase the cost of equity, all else held constant? Increase in the dividend growth rate Decrease in beta Decrease in future dividends Increase in stock price Decrease in market risk premium

Increase in the dividend growth rate

Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent? Portfolio variance Portfolio standard deviation Portfolio weight Portfolio expected return Portfolio beta

Portfolio weight

Farmer's Supply is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion. Which one of the following terms describes this evaluation approach? Equity approach Aftertax approach Subjective approach Market play Pure play approach

Pure play approach

Which one of the following could cause the total return on an investment to be a negative rate? Constant annual dividend amount Increase in the annual dividend amount Stock price that remains constant over the investment period Stock price that declines over the investment period Stock price that increases over the investment period

Stock price that declines over the investment period

Which one of the following statements is correct? The risk-free rate of return has a risk premium of 1.0. The reward for bearing risk is called the standard deviation. Risks and expected return are inversely related. The higher the expected rate of return, the wider the distribution of returns. Risk premiums are inversely related to the standard deviation of returns.

The higher the expected rate of return, the wider the distribution of returns.

Kelly's uses the firm's WACC as the required return for some of its projects. For other projects, the firms uses a rate equal to WACC plus one percent, while another set of projects is assigned rates equal to WACC minus some amount. Which one of the following factors should be the key factor the firm uses to determine the amount of the adjustment it will make when assigning a discount rate to a specific project? The current market rate of interest Actual source of funds used to finance the project The perceived risk level of project The division within the firm that will be assigned to manage the project The firm's current debt-equity ratio

The perceived risk level of project

Which one of the following is used as the pretax cost of debt? Average coupon rate on the firm's outstanding bonds Coupon rate on the firm's latest bond issue Weighted average yield to maturity on the firm's outstanding debt Average current yield on the firm's outstanding debt Annual interest divided by the market price per bond for the latest bond issue

Weighted average yield to maturity on the firm's outstanding debt

A portfolio is: a single risky security. any security that is equally as risky as the overall market. any new issue of stock. a group of assets held by an investor. an investment in a risk-free security.

a group of assets held by an investor.

Systematic risk is defined as: any risk that affects a large number of assets. the total risk of an individual security. diversifiable risk. asset-specific risk. the risk unique to a firm's management.

any risk that affects a large number of assets.

When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return that: is based on the actual source of funds that will be used to fund the project. creates a positive net present value for the project. reflects the size and life of the project. most closely correlates with the proposed investment's internal rate of return. best matches the risk level of the proposed investment.

best matches the risk level of the proposed investment.

The weighted average cost of capital is defined as the weighted average of a firm's: return on all of its investments. cost of equity, cost of preferred, and its aftertax cost of debt. pretax cost of debt and its preferred and common equity securities. bond coupon rates. common and preferred stock.

cost of equity, cost of preferred, and its aftertax cost of debt.

An increase in a levered firm's tax rate will: decrease the cost of preferred stock. increase both the cost of preferred stock and debt. decrease the firm's cost of capital. decrease the cost of equity capital. increase the firm's WACC.

decrease the firm's cost of capital.

The cost of preferred stock: increases when a firm's tax rate decreases. is constant over time. is unaffected by changes in the market price of the stock. is equal to the stock's dividend yield. increases as the price of the stock increases.

is equal to the stock's dividend yield.

The lower the standard deviation of returns on a security, the _____ the expected rate of return and the _____ the risk. lower; lower lower; higher higher; lower higher; higher

lower; lower

Unsystematic risk can be defined by all of the following except: unrewarded risk. diversifiable risk. market risk. unique risk. asset-specific risk.

market risk.

Systematic risk is: totally eliminated when a portfolio is fully diversified. defined as the total risk associated with surprise events. risk that affects a limited number of securities. measured by beta. measured by standard deviation.

measured by beta.