Risk & Return

5. Most of the benefits of diversification can be achieved by investing in only ___________ stocks

15-20 Stocks

What are the 2 main methods for determining cost of capital?

CAPM and Div. Discount model

8. If you believe that the market will be rising during the next year or two, should you choose a stock with a beta of 2, 1, or 0.5? What about the case of an expected decline in the market?

If the market is rising choose 2 If expected decline choose 0.5

6. What is the difference between the market return and the equity market risk premium?

Market return = rm Market risk premium = (rm -rrf)

10. What causes the slope of the security market line to become steeper?

More risk aversion in the market

1. Is standard deviation better to use as a measure of risk for an undiversified 1-asset portfolio or for a stock held as a part of a well-diversified portfolio?

Standard deviation is better to use as a measure of risk for an undiversified 1-asset portfolio

What is the role of the stockholders, board directors, and the management team in corporate governance?

Stockholders choose board of directors Board directors oversee the mgmt team Mgmt team runs business

7. What is the β (Beta) of the (a) risk-free asset and (b) market portfolio?

a. 0 b.1

9. For the following decisions, indicate if they are consistent with risk averse of risk loving behavior? a. Buying a lottery ticket. b. Buying fire insurance for your house c. Backing up you computer

a. Risk loving b. Risk averse c. Risk averse

What are the accept rules of for NPV and IRR?

accept if NPV is greater than 0

When calculating WACC which capital is excluded and why?

acrruals, and accounts payable

What is the main MIRR over the IRR

better investment assumption

Which cost used in the WACC needs to be multiplied by (1-t)

cost of debt

What are two models used by financial analysts to estimate the price of a stocl

dividend discount model price to earning model

In what sense is preferred stock preferred over common stock?

get their dividend paid before

In the case of independent projects, would NPV and IRR ever lead to different decisions

no

What are the two main criticisms of payback and capital budgeting tequniche?

no time value money and it ignores cash flows

Why is it a problem to have more than 1 sign change in our cash flows?

opens up possibly more than 1 IRR

4. When combining two assets as a part of a 2-asset portfolio, which correlation coefficient provides the total diversification benefit?

r= -1 (perfect diversification) r=1(No diversification benefit)

What is the preemptive right associated with a stock?

risk to maintain existing share of stockholdership

How can one find the before tax cost of debt?

take the IRR

What do common shareholders get in addition to possible dividends?

voting rights, capital gains

3.What is the main measure of systematic risk?

β (Beta) Indicates how stock moves relative to overall market

2. Total Risk = Diversifiable risk + Systematic Risk Which source of risk becomes the relevant risk for a stock held as in a well-diversified portfolio?

β (Beta) is a measure of systematic risk relevant for a stock held in a well diversified portfolio