FRL 301 Final Exam

The LIBOR is primarily used as the basis for the rate charged on: - Short-term debt in the Lisbon market. - Mortgage loans in the Lisbon market. - Eurodollar loans in the London market. - U.S. federal funds. - Interbank loans in the U.S.

Eurodollar loans in the London market.

A trader has just agreed to exchange $2 million U.S. for €1.55 million six months from today. This exchange is an example of a: - Spot trade. - Forward trade. - Short sale. - Floating swap. - Triangle arbitrage.

Forward trade.

The dividend growth model cannot be used to compute the cost of equity for a firm that: - Pays an increasing dividend. - Reduces its dividend on a regular basis. - Has a dividend payout ratio of 100 percent. - Pays a constant dividend year after year. - Has a retention ratio of 100 percent.

Has a retention ratio of 100 percent.

Which of the following statements concerning risk are correct? I. Non diversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for non diversifiable risk. IV. Diversifiable risks are market risks you cannot avoid. - I and III only. - II and IV only. - I and II only. - III and IV only. - I, II, and III only.

I and III only.

Which one of the following is an example of diversifiable risk? I Earthquake damages an entire town. II Federal government imposes a $100 fee on all business entities III Employment taxes increase nationally. IV Toymakers are required to improve their safety standards. - I and III only. - II and IV only. - II and III only - I and IV only. - I, III, and IV only

I and IV only.

Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in 30 unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk. - I and III only. - II and IV only. - I and IV only. - I, II and III only. - I, II, III, and IV.

I, II and III only.

The expected return on a portfolio considers which of the following factors? I Percentage of the portfolio invested in each individual security. II Projected states of the economy. III The performance of each security given various economic states. IV Probability of occurrence for each state of the economy. - I and III only - II and IV only - I, III, and IV only - II, III, and IV only - I, II, III, and IV

I, II, III, and IV

Changes in the net working capital requirements: - Can affect the cash flows of a project every year of the project's life. - Only affect the initial cash flows of a project. - Only affect the initial and final cash flows of a project. - Are generally excluded from project analysis due to their irrelevance to the total project. - Are excluded from the analysis as long as they are recovered when the project ends.

Can affect the cash flows of a project every year of the project's life.

The standard deviation of a portfolio: - Is a measure of that portfolio's systematic risk. - Is a weighted average of the standard deviations of the individual securities held in that portfolio. - Measures the amount of diversifiable risk inherent in the portfolio. - Serves as the basis for computing the appropriate risk premium for that portfolio. - Can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

Can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? - Capital asset pricing model - Time value of money equation - Unsystematic risk equation - Market performance equation - Expected risk formula

Capital asset pricing model

Which one of the following is an example of unsystematic risk? - Income taxes are increased across the board. . A national sales tax is adopted. - Inflation decreases at the national level. - An increased feeling of prosperity is felt around the globe. - Consumer spending on entertainment decreased nationally.

Consumer spending on entertainment decreased nationally.

reynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the: - Average arithmetic return. - Expected return. - Market rate of return. - Internal rate of return. - Cost of capital.

Cost of capital.

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called? - Dividend yield. - Cost of equity. - Capital gains yield. - Cost of capital. - Income return.

Cost of equity.

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that: - Stock A is riskier than stock B and both stocks are fairly priced. - Stock A is less risky than stock B and both stocks are fairly priced. - Either stock A is underpriced or stock B is overpriced or both. - Either stock A is overpriced or stock B is underpriced or both. - Both stock A and stock B are correctly priced since stock A is riskier than stock B.

Either stock A is overpriced or stock B is underpriced or both.

The primary purpose of portfolio diversification is to: - Increase returns and risks. - Eliminate all risks. - Eliminate asset-specific risk. - Eliminate systematic risk. - Lower both returns and risks.

Eliminate asset-specific risk.

International bonds issued in multiple countries but denominated in a single currency are called: - Treasury bonds. - Bulldog bonds. - Eurobonds. - Yankee bonds. - Samurai bonds.

Eurobonds.

U.S. dollars deposited in a bank in Switzerland are called: - Foreign depository receipts. - International exchange certificates. - Francs. - Eurocurrency. - Eurodollars.

Eurocurrency.

The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's: - Incremental cash flows. - Internal cash flows. - External cash flows. - Erosion effects. - Financing cash flows.

Incremental cash flows.

The condition stating that the interest rate differential between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate is called: - The unbiased forward rates condition. - Uncovered interest rate parity. - The international Fisher effect. - Purchasing power parity. - Interest rate parity.

Interest rate parity.

Which one of the following supports the idea that real interest rates are equal across countries? - Unbiased forward rates condition. - Uncovered interest rate parity. - International Fisher effect. - Purchasing power parity. - Interest rate parity.

International Fisher effect.

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock: - Is underpriced. - Is correctly priced. - Will plot below the security market line. - Will plot on the security market line. - Will plot to the right of the overall market on a security market line graph.

Is underpriced.

Which one of the following states that the value of a firm is unrelated to the firm's capital structure? Homemade leverage. - M&M Proposition I, no tax. - M&M Proposition II, no tax. - Pecking-order theory. - Static theory of capital structure.

M&M Proposition I, no tax.

Which one of the following is represented by the slope of the security market line? - Reward-to-risk ratio - Market standard deviation - Beta coefficient - Risk-free interest rate - Market risk premium

Market risk premium

Relative purchasing power parity: - States that identical items should cost the same regardless of the currency used to make the purchase. - Relates differences in inflation rates to differences in exchange rates. - Compares the real rate of return to the nominal rate of return. - Explains the differences in real rates across national boundaries. - Relates future exchange rates to current spot rates.

Relates differences in inflation rates to differences in exchange rates.

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly? - Variance - Standard deviation - Reward-to-risk ratio - Beta - Risk premium

Reward-to-risk ratio

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the: - Market risk premium. - Risk premium. - Systematic return. - Total return. - Real rate of return.

Risk premium.

Standard deviation measures which type of risk? - Total - Non diversifiable - Unsystematic - Systematic - Economic

Total

Which one of the following states that the current forward rate is an unbiased predictor of the future spot exchange rate? - Unbiased forward rates. - Uncovered interest rate parity. - International Fisher effect. - Purchasing power parity. - Interest rate parity.

Unbiased forward rates.

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by 20 percent. What type of risk does this news flash best represent? - Portfolio - Non diversifiable - Market - Unsystematic - Total

Unsystematic

Which one of the following risks is irrelevant to a well-diversified investor? - Systematic risk. - Unsystematic risk. - Market risk. - Non diversifiable risk. - Systematic portion of a surprise

Unsystematic risk.

Which one of the following is the primary determinant of a firm's cost of capital? - Debt-equity ratio. - Applicable tax rate. - Cost of equity. - Cost of debt. - Use of the funds.

Use of the funds.

Which one of the following costs was incurred in the past and cannot be recouped? - Incremental. - Side. - Sunk. - Opportunity. - Erosion.

sunk

The depreciation tax shield is best defined as the: - Amount of tax that is saved when an asset is purchased. - Tax that is avoided when an asset is sold as salvage. - Amount of tax that is due when an asset is sold. - Amount of tax that is saved because of the depreciation expense. - Amount by which the aftertax depreciation expense lowers net income.

Amount of tax that is saved because of the depreciation expense.

The capital structure weights used in computing a firm's weighted average cost of capital: - Are based on the book values of the firm's debt and equity. - Are based on the market values of the firm's debt and equity securities. - Depend upon the financing obtained to fund each specific project. - Remain constant over time unless the firm issues new securities. - Are restricted to the firm's debt and common stock.

Are based on the market values of the firm's debt and equity securities.

Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should: - Allocate more funds to Division A since it is the largest of the two divisions. - Fund all of Division B's projects first since they tend to be less risky and then allocate the remaining funds to the Division A projects that have the highest net present values. - Allocate the company's funds to the projects with the highest net present values based on the firm's weighted average cost of capital. - Assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values. - Fund the highest net present value projects from each division based on an allocation of 70 percent of the funds to Division A and 30 percent of the funds to Division B.

Assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.

The capital asset pricing model approach to equity valuation: - Is dependent upon the unsystematic risk of a security. - Assumes the reward-to-risk ratio increases as beta increases. - Can only be applied to dividend-paying firms. - Assumes a firm's future risks will be higher than its current risks. - Assumes the reward-to-risk ratio is constant.

Assumes the reward-to-risk ratio is constant.

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset? - Beta - Reward-to-risk ratio - Risk ratio - Standard deviation - Price-earnings ratio

Beta

High Adventure is considering a new project that is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of .55 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity? - By adding the market risk premium to the aftertax cost of debt. - By multiplying the market risk premium by 1.55. - By using the dividend growth model. - By using the capital asset pricing model. - By averaging the costs based on the dividend growth model and the capital asset pricing model.

By using the capital asset pricing model.

If a stock portfolio is well diversified, then the portfolio variance: - Will equal the variance of the most volatile stock in the portfolio. - May be less than the variance of the least risky stock in the portfolio. - Must be equal to or greater than the variance of the least risky stock in the portfolio. - Will be a weighted average of the variances of the individual securities in the portfolio. - Will be an arithmetic average of the variances of the individual securities in the portfolio.

May be less than the variance of the least risky stock in the portfolio.

Which one of the following formulas expresses the absolute purchasing power parity relationship between the U.S. dollar and the British pound? - S0 = PUK × PUS - PUS = Ft × PUK - PUK = S0 × PUS - Ft = PUS × PUK - S0 × Ft = PUK × PUS

PUK = S0 × PUS

Jenner's is a multi division firm that uses its overall WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to: - Receive less project funding if its line of business is riskier than that of the other divisions. - Avoid risky projects so it can receive more project funding. - Become less risky over time based on the projects that are accepted. - Have an equal probability with all the other divisions of receiving funding. - Prefer higher risk projects over lower risk projects.

Prefer higher risk projects over lower risk projects.

Three years ago, Knox Glass purchased a machine for a three-year project. The machine is being depreciated straight-line to zero over a five-year period. Today, the project ended and the machine was sold. Which one of the following correctly defines the aftertax salvage value of that machine? (T represents the relevant tax rate) - Sale price + (Sale price - Book value) ×T - Sale price + (Sale price - Book value) ×(1 - T) - Sale price + (Book value - Sale price) ×T - Sale price + (Book value - Sale price) ×(1 - T) - Sale price ×(1 - T)

Sale price + (Book value - Sale price) ×T

Which one of the following conditions is not required for absolute purchasing power parity to exist? - No trade barriers can exist. - Goods must be identical. - Transaction costs must be zero. - There can be no spoilage. - Spot and forward rates must be equal.

Spot and forward rates must be equal.

Trader A has agreed to give 100,000 U.S. dollars to Trader B in exchange for British pounds based on today's exchange rate of $1 = £.5928. The traders agree to settle this trade within two business days. What is this exchange called? - Swap - Option trade - Futures trade - Forward trade - Spot trade

Spot trade

The principle of diversification tells us that: - Concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. - Concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. - Spreading an investment across five diverse companies will not lower the total risk. - Spreading an investment across many diverse assets will eliminate all of the systematic risk. - Spreading an investment across many diverse assets will eliminate some of the total risk.

Spreading an investment across many diverse assets will eliminate some of the total risk.

Total risk is measured by _____ and systematic risk is measured by _____. - Beta; alpha. - Beta; standard deviation. - Alpha; beta. - Standard deviation; beta. - Standard deviation; variance.

Standard deviation; beta.

The market risk premium is computed by: - Adding the risk-free rate of return to the inflation rate. - Adding the risk-free rate of return to the market rate of return. - Subtracting the risk-free rate of return from the inflation rate. - Subtracting the risk-free rate of return from the market rate of return. - Multiplying the risk-free rate of return by a beta of 1.0.

Subtracting the risk-free rate of return from the market rate of return.

Which one of the following is a risk that applies to most securities? - Unsystematic - Diversifiable - Systematic - Asset-specific - Total

Systematic

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk. - Efficient markets hypothesis - Systematic risk principle - Open markets theorem - Law of one price - Principle of diversification

Systematic risk principle

Which one of the following best describes the concept of erosion? - Expenses that have already been incurred and cannot be recovered. - Change in net working capital related to implementing a new project. - The cash flows of a new project that come at the expense of a firm's existing cash flows. - The alternative that is forfeited when a fixed asset is utilized by a project. - The differences in a firm's cash flows with and without a particular project.

The cash flows of a new project that come at the expense of a firm's existing cash flows.

Which one of these will increase a firm's aftertax cost of debt? - a Decrease in the market value of the firm's outstanding bonds. - a Decrease in the firm's tax rate. - An increase in the bond's credit rating. - An increase in the firm's beta. - A Decrease in the market rate of interest.

a Decrease in the firm's tax rate.

Flotation costs for a levered firm should: - be ignored when analyzing a project because they are a sunk cost. - be spread over the life of a project thereby reducing the cash flows for each year of the project. - only be considered only when two projects are mutually exclusive. - be weighted and included in the initial cash flow. - be totally ignored when internal equity funding is utilized.

be weighted and included in the initial cash flow.