FINANCE- TEST 1 MC

4. The S&P 500 index traditionally is a ________ portfolio of the 500 largest U.S. stocks. a. value weighted b. equally weighted c. chain weighted d. price weighted

4. VALUE WEIGHTED

5. Is volatility a reasonable measure of risk when evaluating large portfolios? a. True b. False

5. TRUE

28. If beta of Selleck & Company is negative, the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor. a. True b. False

A. TRUE

7. If the returns on a stock index can be characterized by a normal distribution with mean 12%, the probability that returns will be lower than 12% over the next period equals: a. 50% b. 25% c. 46% d. 33%

A. 50%

20. For each 1% change in the market risk premium, the investment's excess return is expected to change by ________ percent due to risks that it has in common with the market (systematic risk). a. beta b. alpha c. zero d. cannot say for sure

A. BETA

8. Because investors can eliminate unsystematic risk "for free" by diversifying their portfolios, they ________ a risk premium for bearing it. a. do not require b. require c. are indifferent about d. none of the above

A. DO NOT REQUIRE

37. Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would shift in this manner: a. Down and have a steeper slope. b. Up and have a less steep slope. c. Up and keep the same slope. d. Down and keep the same slope. e. Down and have a less steep slope.

A. DOWN AND HAVE A STEEPER SLOPE

1. On average, stocks with high returns are expected to have a. high variability. b. low variability. c. no relation to variability. d. inverse relationship with variability

A. HIGH VARIABILITY

2. Historically, stocks have delivered a ________ return on average compared to Treasury bills but have experienced ________ fluctuations in values. a. higher, higher b. higher, lower c. lower, higher d. lower, lower

A. HIGHER, HIGHER

5. The standard deviation of returns of: I. small capitalization stocks is higher than that of large capitalization stocks. II. large capitalization stocks is lower than that of corporate bonds. III. corporate bonds is higher than that of Treasury bills. Which statement is true? a. I and III b. I, II, and III c. I and II d. I only

A. I AND III

12. Which of the following is NOT a diversifiable risk? a. Inflation b. the risk that the CEO is killed in a plane crash c. the risk of a key employee being hired away by a competitor d. the risk of a product liability lawsuit

A. INFLATION

25. A portfolio of stocks can achieve diversification benefits if the stocks that comprise the portfolio are A. not perfectly correlated. B. perfectly correlated. C. susceptible to market-wide risks only D. Both B and C

A. NOT PERFECTLY CORRELATED

39. Based on historical data, which of the following statements is FALSE? a. On average, larger stocks have higher volatility than smaller stocks. b. Portfolios of large stocks are typically less volatile than individual large stocks. c. On average, smaller stocks have higher returns than larger stocks. d. On average, Treasury Bills have lower returns than corporate bonds.

A. ON AVERAGE, LARGER STOCKS HAVE HIGHER VOLATILITY THAN SMALLER STOCKS

15. A sole proprietorship is owned by a. One person. b. Two or more persons. c. Shareholders. d. Bankers.

A. ONE PERSON

1. Which of the following types of firms do not have limited liability? a. Sole proprietorships b. Limited partnerships c. Corporations d. None of the above

A. SOLE PROPRIETORSHIPS

3. What is the most common type (in terms of numbers) of firm in the United States and the world? a. Sole proprietorships b. Partnerships c. Limited partnerships d. Corporations

A. SOLE PROPRIETORSHIPS

23. What is the bid-ask spread? a. The difference in price available for an immediate sale of a stock and the immediate purchase of that stock b. All of the costs and fees that a stock exchange charges in order to process a transaction c. The rise or fall in the value of a stock between the time it is acquired by an investor and sold by that investor d. The difference in the selling price of a stock between different exchanges

A. THE DIFFERENCE IN PRICE IS AVAILABLE FOR AN IMMEDIATE SALE OF A STOCK AND THE IMMEDIATE PURCHASE OF THAT STOCK

16. For markets to be in equilibrium/efficient (that is, for all current information be incorporated into stock prices), a. The expected rate of return must be equal to the required rate of return b. The past realized rate of return must be equal to the expected rate of return. c. The required rate of return must equal the realized rate of return d. All three of the above statements must hold for equilibrium to exist. e. None of the above statements is correct.

A. THE EXPECTED RATE OF RETURN MUST BE EQUAL TO THE REQUIRED RATE OF RETURN

24. Which of the following statements is FALSE? a. The risk premium of a security is equal to the market risk premium (the amount by which the market's expected return exceeds the risk-free rate) divided by beta of the asset. b. Investors do not earn a risk premium for bearing unsystematic risk c. There is a linear relationship between a stock's beta and its expected return. d. A security with a negative beta has a negative correlation with the market, which means that this security tends to perform well when the rest of the market is doing poorly.

A. THE RISK PREMIUM OF A SECURITY IS EQUAL TO THE MARKET RISK PREMIUM (THE AMOUNT BY WHICH THE MARKET'S EXPECTED RETURN EXCEEDS THE RISK-FREE RATE) DIVIDED BY BETA OF THE ASSET

24. Whose interests should a financial manager consider paramount when making a decision? a. The stockholders who have risked their money to become owners of the company b. The employees and associated stakeholders who are employed by the company c. The public who consume the company's goods and services d. The senior management and associated colleagues at the executive level within the company

A. THE STOCKHOLDERS WHO; HAVE RISKED THEIR MONEY TO BECOME OWNERS OF THE COMPANY

22. Which of the following statements is FALSE? a. The variance of a portfolio depends only on the variance of the individual stocks. b. Independent risks are uncorrelated. c. Because the prices of the stocks do not move identically, some of the risk is averaged out in a portfolio. d. To find the risk of a portfolio, we need to know more than the risk and return of the component stocks; we need to know the degree to which the stocks' returns move together.

A. THE VARIANCE OF A PORTFOLIO DEPENDS ONLY ON THE VARIANCE OF THE INDIVIDUAL STOCKS

3. Investors demand a higher return for investments that have larger fluctuations in values because a. they do not like risk. b. they are risk seeking. c. they invest for the long term. d. none of the above

A. THEY DO NOT LIKE RISK

10. When we combine stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks face common risks and move together. a. TRUE b. FALSE

A. TRUE

11. It is possible for a stock to have high total risk but low systematic risk. a. True b. False

A. TRUE

15. A portfolio comprises two stocks, A and B, with equal amounts of money invested in each. If stock A's stock price increases and that of stock B decreases, the weight of stock A in the portfolio will increase. a. TRUE b. FALSE

A. TRUE

16. Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky. a. TRUE b. FALSE

A. TRUE

20. When adding a new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and those already in the portfolio, the less the additional stock will reduce the portfolio's risk. a. TRUE b. FALSE

A. TRUE

22. If investors are risk averse and hold only one stock, we can conclude that the return they would require on a stock whose standard deviation is 0.21 will be greater than the return required on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the low standard deviation stock. a. True b. False

A. TRUE

25. "Risk aversion" implies that investors require higher expected returns on risky securities if they are to be induced to purchase them. a. True b. False

A. TRUE

26. Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific" events, and their effects on investment risk can in theory be diversified away. a. True b. False

A. TRUE

3. A portfolio of stocks where each stock has a large component of idiosyncratic risk benefits when such stocks are held in a portfolio, because the idiosyncratic risks are averaged out. This is also referred to as diversification of risks. a. True b. False

A. TRUE

9. The correlation of the returns of the two assets does not play any role in computation of the expected return of the two asset portfolio. a. TRUE b. FALSE

A. TRUE

10. Many former employees at Enron, an energy trading and supply company, had a large part of their portfolio invested in Enron stock. These employees were bearing a high degree of ________ risk. a. unsystematic b. systematic c.market specific d. non-diversifiable

A. UNSYSTEMATIC

1. While ________ seems to be a reasonable measure of risk when evaluating a large portfolio, the ________ of an individual security does not explain the size of its average return. a. volatility, volatility b. the mean return, standard deviation c. mode, volatility d. none of the above

A. VOLATILITY, VOLATILITY

17. Which of the following equations is INCORRECT? a. wi = Total value of portfolio/ Value of investment i b. Rp =w1R1 +w2R2 +...+wnRn c. E[Rp] = w1E[R1]+ w2E[R2]+..+wnE[Rn] d. All are correct

A. WI= TOTAL VALUE OF PORTFOLIO/VALUE OF INVESTMENT

8. Which of the following statements is FALSE? a. Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return. b. The expected return of a portfolio is simply the weighted average of the expected returns of the investments within the portfolio. c. Portfolio weights add up to 1 so that they represent the way we have divided our money between the different individual investments in the portfolio. d. A portfolio weight is the fraction of the total investment in the portfolio held in an individual investment in the portfolio.

A. WITHOUT TRADING, THE PORTFOLIO WEIGHTS WILL DECREASE FOR THE STOCKS IN THE PORTFOLIO WHOSE RETURNS ARE ABOVE THE OVERALL PORTFOLIO RETURN

15. You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM) to be 1.9 over the next year. Also, you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year. Which stock has more systematic risk? Which stock has more total risk? a. XOM, GM b. GM, XOM c. GM, GM d. XOM, XOM

A. XOM, GM

36. You have the following data on three stocks: Stock-- Standard D.--Beta Stock A --0.15--0.79 Stock B --0.25--0.61 Stock C--0.20--1.29 As a risk minimizer, you would choose Stock____ if it is to be held in isolation and Stock____ if it is to be held as part of a well-diversified portfolio. a. A;A. b. A;B. c. B;C. d. C;A. e. C;B.

B. A;B

25. How do the shareholders of most corporations exercise their control of that corporation? a. By voting on issues that concern them b. By electing members of a board of directors c. By vetting every decision made by the board of directors d. By providing oversight of the day to day running of the corporation

B. BY ELECTING MEMBERS OF A BOARD OF DIRECTORS

23. Stocks tend to move together if they are affected by a. company specific events. b. common economic events. c. unrelated to the economy. d. idiosyncratic shocks.

B. COMMON ECONOMIC EVENTS

21. Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions with positive weights, the resulting 2-asset portfolio can have less risk than either security held alone. a. TRUE b. FALSE

B. FALSE

24. A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio. A. TRUE B. FALSE

B. FALSE

35. Portfolio A has one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B is by definition riskless. a. TRUE b. FALSE

B. FALSE

6. Is volatility a reasonable measure of risk when evaluating the investment in a single stock? a. True b. False

B. FALSE

30. Which of the following is a primary market transaction? a. You sell 200 shares of IBM stock on the NYSE through your broker. b. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker. c. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker--you just give him cash and he gives you the stock. d. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction. e. You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of IBM shares on the NYSE.

B. IBM ISSUES 2,000,000 SHARES OF NEW STOCK AND SELLS THEM TO THE PUBLIC THROUGH AN INVESTMENT BANKER

33. Put the following steps of the financial cycle in the correct order: I. Money flows to companies who use it to fund growth through new products II. People save and invest their money III. Money flows back to savers and investors a. I, II, III b. II, I, III c. III, II, I d. II, III, I

B. II, I, III

12. The volatility of Home Depot stock returns is 30% and that of General Motors stock is 30%. When I hold both stocks in my portfolio and the stocks returns have zero correlation, the overall volatility of returns of the portfolio is a. unchanged at 30%. b. less than 30%. c. more than 30%. d. cannot say for sure

B. LESS THAN 30%

23. Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away. These stocks tend to have ________ betas. a. high b. low c. negative d. cannot say for sure

B. LOW

16. Which of the following statements is CORRECT? a. In a regular partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business. b. Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. c. A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company. d. In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business. Also, the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy. e. A major disadvantage of all partnerships relative to all corporations is the fact that federal income taxes must be paid by the partners rather than by the firm itself.

B. PARTNERSHIPS HAD MORE DIFFICULTY ATTRACTING LARGE AMOUNTS OF CAPITAL THAN CORPORATIONS BECAUSE OF SUCH FACTORS AS UNLIMITED LIABILITY, THE NEED TO REORGANIZE WHEN A PARTNER DIES, AND THE LIQUIDITY (DIFFICULTY BUYING AND SELLING) OR PARTNERSHIP INTERESTS

17. Jane Doe, who has substantial personal wealth and income, is considering the possibility of starting a new business in the chemical waste management field. She will be the sole owner, and she has enough funds to finance the operation. The business will have a relatively high degree of risk, and it is expected that the firm will incur losses for the first few years. However, the prospects for growth and positive future income look good, and Jane plans to have the firm pay out all of its income as dividends to her once it is well established. Which of the legal forms of business organization would probably best suit her needs? a. Proprietorship, because of ease of entry. b. S corporation, to gain some tax advantages and also to obtain limited liability. c. Partnership, but only if she needs additional capital. d. Regular corporation, because of the limited liability. e. In this situation, the various forms of organization seem equally desirable.

B. S CORPORATION, TO GAIN SOME TAX ADVANTAGES AND ALSO TO OBTAIN LIMITED LIABILITY

28. Why is a stock exchange like NASDAQ considered a secondary market? a. It trades the second largest volume of shares in the world. b. Shares sold on it are exchanged between investors without any involvement of the issuing corporation. c. The exchange has rules that attempt to ensure that bid and ask prices do not get too far apart d. NASDAQ is called a secondary market because NYSE is considered a primary market.

B. SHARES SOLD ON IT ARE EXCHANGED BETWEEN INVESTORS WITHOUT ANY INVOLVEMENT OF THE ISSUING CORPORATION

9. What is the process of double taxation for the stockholders in a C corporation? a. Their shares are taxed when they are both bought and sold. b. The corporation is taxed on the profits it makes, and the owners are taxed when this profit is distributed to them. c. The owners of a corporation are taxed when they receive dividend payments and when they make a profit from the sale of shares. d. The corporation must pay taxes on any profits it makes, and the capital raised by the sale of shares is also subject to taxation.

B. THE CORPORATION IS TAXED ON THE PROFITS IT MAKES, AND THE OWNERS ARE TAXED WHEN THIS PROFIT IS DISTRIBUTED TO THEM

31. Which of the following statements is CORRECT? a. If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1) and the stocks have equal standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks. b. The market portfolio will have a higher beta than a single stock that has a beta of 0.5. c. If a stock has a negative beta, its expected return must be negative. d. The market portfolio will have a lower beta than a single stock that has a beta of 0.5. e. According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

B. THE MARKET PORTFOLIO WILL HAVE A HIGHER BETA THAN A SINGLE STOCK THAT HAS A BETA OF 0.5

18. In the market portfolio, you can diversify away all _______ risk, but you will be left with ________ risk. a. diversifiable, unsystematic b. unsystematic, systematic c. systematic, undiversifiable d. diversifiable, diversifiable

B. UNSYSTEMATIC, SYSTEMATIC

21. The beta of the market portfolio is: a. 0 b. -1 c. 2 d. 1

D. 1

14. Which of the following statements is CORRECT? a. A hostile takeover is the main method of transferring ownership interest in a corporation. b. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. c. A corporation is a legal entity that is generally created by a state, and it has a life and existence that is separate from the lives of its individual owners and managers. d. Limited liability of its stockholders is an advantage of the corporate form of organization, but corporations have more trouble raising money in financial markets because of the complexity of this form of organization. e. Although its stockholders are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way, i.e., bondholders can sue its managers if the firm defaults on its debt, even if the default is the result of poor economic conditions.

C. A CORPORATION IS A LEGAL ENTITY THAT IS GENERALLY CREATED BY A STATE, AND IT HAS A LIFE AND EXISTENCE THAT IS SEPARATE FROM THE LIVES OF ITS INDIVIDUAL OWNERS AND MANAGERS

29. You recently sold to your brother 200 shares of Disney stock, and the transfer was made through a broker, and the trade occurred on the NYSE. This is an example of a. A futures market transaction. b. A primary market transaction. c. A secondary market transaction. d. A money market transaction. e. An over-the-counter market transaction.

C. A SECONDARY MARKET TRANSACTION

8. In which of the following ways is a limited liability company like a corporation? a. Both types of firm were created and developed first in the United States. b. Both can choose to be considered a partnership for tax purposes. c. All of its owners' liability is restricted to their investment in the firm. d. It is directly managed by the owners of the firm.

C. ALL OF ITS OWNERS' LIABILITY IS RESTRICTED TO THEIR INVESTMENT IN THE FIRM

19. Which of the following statements is FALSE? a. Stock returns will tend to move together if they are affected similarly by economic events. b. Stocks in the same industry tend to have more highly correlated returns than stocks in different industries. c. Almost all of the correlations between stock returns are negative, illustrating the general tendency of stocks to move together. d. With a positive amount invested in each stock, the more the stocks move together and the higher their correlation, the more variable the portfolio returns will be.

C. ALMOST ALL OF THE CORRELATIONS BETWEEN STOCK RETURNS ARE NEGATIVE, ILLUSTRATING THE GENERAL TENDENCY OF STOCKS TO MOVE TOGETHER

29. Inflation, recession and high interest rates are economic events that are best characterized as being a. systematic risk factors that can be diversified away. b. company-specific risk factors that can be diversified away. c. among the factors that are responsible for market risk. d. risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers. e. irrelevant except to governmental authorities like the Federal Reserve.

C. AMONG THE FACTORS THAT ARE RESPONSIBLE FOR MARKET RISK.

4. Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership? a. Corporations generally face fewer regulations. b. Corporations generally face lower taxes. c. Corporations generally find it easier to raise capital. d. Corporations enjoy unlimited liability. e. Statements c and d are correct.

C. CORPORATIONS GENERALLY FIND IT EASIER TO RAISE CAPITAL

7. As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio a. increases. b. remains unchanged. c. decreases. d. none of the above

C. DECREASES

17. Which of the following statements is FALSE? a. The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk. b. When we combine many stocks in a large portfolio (e.g., in the market portfolio), the firm-specific risks for each stock will average out and be diversified. c. Fluctuations of a stock's returns that are due to firm-specific news are common risks. d. The volatility in a large portfolio will decline until only the systematic risk remains.

C. FLUCTUATIONS OF A STOCK'S RETURNS THAT ARE DUE TO FIRM-SPECIFIC NEWS ARE COMMON RISKS

33. Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.) a. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0. b. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. c. If the market risk premium increases by 1%, then the required return of a stock will increase by its Beta. d. The effect of a change in the market risk premium depends on the level of the risk-free rate.

C. IF THE MARKET RISK PREMIUM INCREASES BY 1%, THEN THE REQUIRED RETURN OF A STOCK WILL INCREASE BY ITS BETA

19. The market portfolio is the portfolio of all risky investments held a. in descending weights. b. in ascending weights. c. in proportion to their value. d. based on previous year performance

C. IN PROPORTION TO THEIR VALUE

18. We can reduce volatility by investing in less than perfectly correlated assets through diversification because the expected return of a portfolio is the weighted average of the expected returns of its stocks, but the volatility of returns of a portfolio a. is higher than the weighted average volatility of the assets in the portfolio. b. is independent of weights of the assets in the portfolio. c. is less than the weighted average volatility of the assets in the portfolio. d. depends on the expected return of the assets in the portfolio.

C. IS LESS THAN THE WEIGHTED AVERAGE VOLATILITY OF THE ASSETS IN THE PORTFOLIO

6. Joe is a general partner in a limited partnership firm, while Jane is a limited partner in that same firm. Which of the following statements regarding their respective relationships to the firm are correct? a. Joe has no management authority within the partnership. b. Jane is legally involved in the managerial decision making of the firm. c. Jane's liability for the firm's debts consists solely of her investment in the firm. d. Withdrawal of Jane from the partnership will dissolve that partnership.

C. JANE'S LIABILITLY FOR THE FIRM'S DEBTS CONSISTS SOLELY OF HER INVESTMENT IN THE FIRM

14. The volatility of Home Depot and General Motors stock returns are identical; volatility of returns for each stock is 30%. When I hold both stocks in my portfolio with an equal amount in each, and the stocks returns have a correlation of less than 1, the overall volatility of returns of the portfolio is a. more than 30%. b. unchanged at 30%. c. less than 30%. d. cannot say for sure

C. LESS THAN 30%

12. Which of the following people may not manage the operations of a firm in which they are part or full owners? a. Stockholders in S corporations b. Stockholders in C corporations c. Limited partners in a limited partnership d. General partners in a limited partnership

C. LIMITED PARTNERS IN A LIMITED PARTNERSHIP

32. Which of the following statements is CORRECT? a. Corporations generally are subject to fewer regulations and more favorable tax treatment than sole proprietorships and partnerships. This is why corporations do most of the business in the United States. b. Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value than are managers who do not face the threat of hostile takeovers. c. One advantage of the corporate form of organization is that liability of the owners of the firm is limited to their investment in the firm. d. Because of their simplified organization, it is easier for sole proprietorships and partnerships to raise large amounts of outside capital than it is for corporations. e. A good goal for a firm's management is maximization of expected EPS.

C. ONE ADVANTAGE OF THE CORPORATE FORM OF ORGANIZATION IS THAT LIABILITY OF THE OWNERS OF THE FIRM IS LIMITED TO THEIR INVESTMENT IN THE FIRM

34. Which of the following is not a role of financial institutions? a. Moving funds from savers to borrowers. b. Spreading out risk-bearing. c. Printing money for borrowers. d. Moving funds though time.

C. PRINTING MONEY FOR BORROWERS

4. Which of the following investments offered the highest overall return over the past eighty years? a. Treasury bills b. S&P 500 c. Small stocks d. Corporate bonds

C. SMALL STOCKS

6. Over the past 75 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last? a. Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills. b. Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. c. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. d. U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. e. Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

C. SMALL-COMPANY STOCKS, LARGE-COMPANY STOCKS, LONG-TERM CORPORATE BONDS, LONG-TERM GOVERNMENT BONDS, U.S. TREASURY BILLS

5. Which of the following is typically the major factor in limiting the growth of a sole proprietorship? a. The organization of such firms tends to become extremely complicated over time. b. It is impossible to transfer control of such a firm to a new owner if the present owner dies or wishes to sell the firm. c. The amount of money that can be raised by the firm is limited by the fact that there is a single owner and that the single owner must make good on all debts. d. Investors have a great deal of control over the day-to-day running of the firm, leading to confusion when conflicts in direction arise.

C. THE AMOUNT OF MONEY THAT CAN BE RAISED BY THE FIRM IS UNLIMITED BY THE FACT THAT THERE IS A SINGLE OWNER AND THAT THE SINGLE OWNER MUST HAVE GOOD ON ALL DEBTS

13. Which of the following is NOT a systematic risk? a. Inflation b. the risk that the economy slows, reducing demand for your firm's products c. the risk that your new product will not receive regulatory approval d. the risk that the Federal Reserve raises interest rates

C. THE RISK THAT YOUR NEW PRODUCT WILL NOT RECEIVE REGULATORY APPROVAL

30. Which of the following statements is CORRECT? a. The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. b. If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. c. The security market line is a graph of the expected return of a stock as a function of systematic risk (beta). d. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks in the portfolio. e. It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, Rrf.

C. THE SECURITY MARKET LINE IS A GRAPH OF THE EXPECTED RETURN OF A STOCK AS A FUNCTION OF SYSTEMATIC RISK (BETA)

13. The volatility of Home Depot stock returns is 30% and that of General Motors stock is 30%. When I hold both stocks in my portfolio and the stocks returns have a correlation of 1, the overall volatility of returns of the portfolio is a. more than 30%. b. less than 30%. c. unchanged at 30%. d. cannot say for sure

C. UNCHANGED AT 30%

14. You expect General Motors (GM) to have a beta of 1 over the next year and the beta of Exxon Mobil (XOM) to be 1.2 over the next year. Also, you expect the volatility of General Motors to be 30% and that of Exxon Mobil to be 40% over the next year. Which stock has more systematic risk? Which stock has more total risk? a. GM, GM b. GM, XOM c. XOM, XOM d. XOM, GM

C. XOM, XOM

18. Which of the following are major duties of a financial manager? I. To make investment decisions II. To make financing decisions III. To manage cash flow from operating activities a. I only b. I and II only c. I and III only d. All of the above

D. ALL OF THE ABOVE

2. The excess return is the difference between the average return on a security and the average return for a. Treasury bonds. b. a portfolio of securities with similar risk. c. a broad-based market portfolio like the S&P 500 index. d. Treasury bills.

D. TREASURY BILLS

11. What is the advantage corporations have over other business entities? a. It is easier for a corporation to raise capital than other forms of businesses. b. A corporation is treated as a separate legal entity in bankruptcy. c. A corporation's shares can be freely traded among its shareholders. d. All of the above are advantages that a corporation has over other business forms.

D. ALL OF THE ABOVE ARE ADVANTAGES THAT A CORPORATION HAS OVER OTHER BUSINESS FORMS

27. Which of the following statements is CORRECT? a. An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. b. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. c. It is impossible to have a situation where the systematic risk of a single stock is less than that of a portfolio that includes the stock. d. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well- diversified portfolio of stocks.

D. AN INVESTOR CAN ELIMINATE VIRTUALLY ALL DIVERSIFIABLE RISK IF HE OR SHE HOLDS A VERY LARGE, WELL-DIVERSIFIED PORTFOLIO OF STOCKS

38. As we add assets to a portfolio where the assets are held in equal weights, the benefit of diversification is most dramatic a. after 20 stocks have been added. b. when there are more than 500 stocks. c. when there are more than 1000 stocks. d. at the outset.

D. AT THE OUTSET

31. Which of the following statements is CORRECT? a. If General Electric were to issue new stock this year it would be considered a secondary market transaction since the company already has stock outstanding. b. Capital market transactions only include preferred stock and common stock transactions. c. If an investor sells shares of stock through a broker, then this would be a primary market transaction. d. Both Nasdaq "dealers" and NYSE "specialists" hold inventories of stocks. e. An electronic communications network (ECN) is a physical location exchange.

D. BOTH NASDAQ "DEALERS" AND NYSE "SPECIALISTS" HOLD INVENTORIES OF STOCKS

2. Over four-fifths of all U.S. business revenue is generated by which type of firm? a. Sole proprietorships b. Partnerships c. Limited partnerships d. Corporations

D. CORPORATIONS

26. Which of the following is NOT a function of the board of directors? a. Determining how top executives should be compensated b. Monitoring the performance of the company c. Answering to shareholders of the company d. Day-to-day running of the company

D. DAY-TO-DAY RUNNING OF THE COMPANY

26. The amount of a stock's risk that is diversified away a. is independent of the portfolio that you add it to. b. depends on market risk premium. c. depends on risk-free rate of interest. d. depends on the portfolio that you add it to. e. depends on the other stocks in the portfolio but not how much is invested in the stocks

D. DEPENDS ON THE PORTFOLIO THAT YOU ADD IT TO

10. Which of the following features of a corporation is LEAST accurate? a. The owners' identity is separate from the corporation. b. The owners of the corporation have limited liability for the corporation's debts. c. Changes in ownership do not result in the dissolution of the corporation. d. Earnings from the corporation are taxed only once.

D. EARNINGS FROM THE CORPORATION ARE TAXED ONLY ONCE

21. A typical company has many types of shareholders, from individuals holding a few shares, to large institutions that hold very large numbers of shares. How does a financial manager ensure that the priorities and concerns of such disparate stockholders are met? a. The financial manager should seek to make investments that do not harm the interests of the stockholders. b. The decisions taken by the financial manager should be solely influenced by the benefit to the company since, by maximizing its fitness, he or she will also maximize the benefits of that company to the shareholders. c. The financial manager should consider the interests and concerns of large shareholders a priority, so the needs of those who hold a controlling interest in the company are met. d. In general, all shareholders will agree that they are better off if the financial manager works to maximize equity value.

D. IN GENERAL, ALL SHAREHOLDERS WILL AGREE THAT THEY ARE BETTER OFF IF THE FINANCIAL MANAGER WORKS TO MAXIMIZE EQUITY VALUE

27. Which of the following need be true for an asset to be considered liquid? a. It pays regular dividends. b. It can be bought and sold at an organized stock market or bourse. c. It is offered for sale on both primary and secondary markets. d. It can be easily bought and sold without affecting the asset's price.

D. IT CAN EASILY BE BOUGHT AND SOLD WITHOUT AFFECTING THE ASSET'S PRICE

13. The primary goal of a manager of a publicly-owned firm (corporation) interested in serving its stockholders should be to a. Maximize expected total corporate profit. b. Maximize expected EPS. c. Minimize the chances of losses. d. Maximize the stock price per share. e. Maximize expected net income.

D. MAXIMIZE THE STOCK PRICE PER SHARE

11. The volatility of Home Depot stock returns is 30% and that of General Motors stock is 30%. When I hold both stocks in my portfolio, the overall volatility of the portfolio is a. 30%. b. 26%. c. 28%. d. more information needed

D. MORE INFORMATION NEEDED

22. Money markets are markets for a. Foreign stocks. b. Consumer automobile loans. c. U.S. stocks. d. Short-term debt securities. e. Long-term bonds.

D. SHORT-TERM DEBT SECURITIES

35. Which of the following statements is CORRECT? a. One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than partners. b. There is no good reason to expect a firm's stockholders and bondholders to react differently to the types of new asset investments a firm makes. c. Bondholders are generally more willing than stockholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns. d. Stockholders are generally more willing than bondholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns. e. Relative to sole proprietorships, corporations generally face fewer regulations, and this makes it easier for corporations to raise capital.

D. STOCKHOLDERS ARE GENERALLY MORE WILLING THAN BONDHOLDERS TO HAVE MANAGERS INVEST IN RISKY PROJECTS WITH HIGH POTENTIAL RETURNS AS OPPOSED TO SAFER PROJECTS WITH LOWER EXPECTED RETURNS

7. What is the major way in which the roles and obligations of the owners of a limited liability company differ from the roles and obligations of limited partners in a limited partnership? a. The owners of a limited liability company have personal obligation for debts incurred by the company. b. The owners in a limited liability company have tax obligations arising from only personal taxes. c. The owners of a limited liability company can withdraw from the company without the company being dissolved. d. The owners of a limited liability company can take an active role in running the company.

D. THE OWNERS OF A LIMITED LIABILITY COMPANY CAN TAKE AN ACTIVE ROLE IN RUNNING THE COMPANY

20. Why in general do financial managers make financial decisions in a corporation, rather than the owners making these decisions themselves? a. The control of the corporation's finances should to be in the hands of a disinterested third party. b. The interests of the various owners may conflict with each other. c. The owners may not be U.S. citizens or residents. d. There are often many owners, and they can often change as they buy and sell stock.

D. THERE ARE OFTEN MANY OWNERS, AND THEY CAN OFTEN CHANGE AS THEY BUY AND SELL STOCK

19. What is the most important duty of a financial officer? a. To ensure that the firm has enough cash on hand to meet its commitments at any given time b. To decide how to pay for investments c. To manage working capital d. To make investment decisions

D. TO MAKE INVESTMENT DECISIONS

32. Which of the following statements is CORRECT? a. A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. b. If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. c. If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. d. A stock with an above-average standard deviation must also have an above-average beta. e. A security's beta measures its non-diversifiable, or systematic, risk.

E. A SECURITY'S BETA MEASURES ITS NON-DIVERSIFIABLE, OR SYSTEMATIC RISK

27. Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., it is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT? a. Portfolio AC has an expected return that is less than 10%. b. Portfolio AC has an expected return that is greater than 10%. c. Portfolio AB has a standard deviation that is greater than 25%. d. Portfolio AB has a standard deviation that is equal to 25%. e. Portfolio AC has a standard deviation that is less than 25%.

E. PORTFOLIO AC HAS A STANDARD DEVIATION THAT IS LESS THAN 25%

9. The risk premium of a security is determined by its ________ risk and does not depend on its ________ risk. a. systematic, undiversifiable b. systematic, unsystematic c. diversifiable, diversifiable d. all of the above

SYSTEMATIC, UNSYSTEMATIC

40. Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT? a. Stock B's required return is double that of Stock A's. b. If investors becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. c. If investors becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. d. If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.

b. If investors becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.

34. Jane has a portfolio of 20 stocks, each stock has a Beta of 1.2; and Dick has a portfolio of 2 stocks, each has a Beta of 1.2. Assuming the market is in equilibrium, which of the following statements is CORRECT? a. Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio. b. The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk. c. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios. d. If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's. e. The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.

c. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios.