Final
A firm's cost of capital should be used as the discount rate for every new project the firm considers
False
A project should be accepted if its return plots below the security market line
False
An increase in a firm's debt ratio will have no effect on the required rate of return for equity holders
False
Diversification with an indefinitely large number of securities completely eliminates risk
False
Diversification works only when returns are uncorrelated
False
The CAPM is a theory of the relationship between risk and return that states that the expected risk premium on any security equals its beta times the market return
False
The risk of a diversified portfolio depends on the specific risk of the individual stocks
False
beta measures the total risk of an individual security
False; market
What is the typical relationship between the standard deviation of an individual common stock and the standard deviation of a diversified portfolio of common stocks?
The individual stock's standard deviation will be higher
Cyclical stocks tend to perform well when other stocks are performing well also
True
For a well-diversified portfolio, only market risk matters
True
If a low-risk company invests in a high-risk project, those cash flows should be discounted at a high cost of capital
True
If stocks were perfectly correlated, diversification would not reduce risk
True
Investors prefer diversified portfolios because they are less risky
True
The CAPM states that the expected risk premium on any security equals its beta times the market risk premium.
True
The company cost of capital is the expected rate of return that investors demand from the company's assets and operations
True
The risk that you can't avoid no matter how much you diversify is known as market risk
True
The security market line displays the relationship between expected return and beta
True
The security market line provides a standard that can be used to make project acceptance/rejection decisions
True
There are two costs of debt finance. The explicit cost of debt is the rate of interest that bondholders demand. But there is also an implicit cost, because higher levels of debt increase the required rate of return to equity
True
What decision should be made on a project with above-average market risk?
Use a higher discount rate than the WACC to reflect the project's risk and accept if NPV is positive at this higher discount rate
To calculate the present value of a business, the firm's free cash flows should be discounted at the firm's
WACC
The benefits of portfolio diversification are highest when the individual securities within the portfolio have returns that:
are largely uncorrelated with the rest of the portfolio
If a security plots below the security market line, it is:
offering too little return to justify its risk
Capital structure decisions refer to the:
blend of equity and debt used by the firm
The major benefit of diversification is the:
reduction in the portfolio's total risk
A stock's beta measures the:
sensitivity of the stock's returns to those of the market portfolio
The slope of the line fitted to a plot of a stocks return versus the returns on the market reflects
specific risk of the stock
If the line measuring a stock's historic returns against the market's historic returns has a slope greater than 1.0, then the:
stock has a beta exceeding 1.0
The slope of the security market line equals:
the market risk premium
The company cost of capital may be an inappropriate discount rate for a capital budgeting proposal if:
the project has a different degree of risk from the company
The average of the betas for all stocks is
exactly 1.0; these stocks represent the market
macro events only are reflected in the performance of market portfolio becuase
the specific risks have been diversified away
The expected return on a security includes a reward for
time value of money and market risk
Which total risk can be diversified away as additional securities are added to a portfolio
total risk and firm specific risk
In a well diversified portfolio
unsystematic risk is negligible