SU7 Gleim

Listed below are four numbers. Which of these numbers represents the coefficient of correlation of a stock portfolio with the least unsystematic risk? A.1.0 B.100.0 C.-1.0 D.0.0

.-1.0Answer (C) is correct. The correlation coefficient measures the degree to which any two variables, e.g., two stocks in a portfolio, are related. Perfect negative correlation (-1.0) means that the two variables always move in the opposite direction. Given perfect negative correlation, unsystematic risk would, in theory, be eliminated.

An analyst covering Guilderland Mining Co. common stock estimates the following information for next year:Expected return on the market portfolio12%Expected return on Treasury securities5%Expected beta of Guilderland2.2Using the CAPM, the analyst's estimate of next year's risk premium for Guilderland's stock is closest to A.15.4% B.21.4% C.7.0% D.10.4%

A.15.4%Answer (A) is correct. According to the capital asset pricing model, the risk premium of a particular stock is the excess of the market rate of return over the risk-free rate weighted by the stock's beta coefficient. For Guilderland Mining, this calculation isStock's risk premium=2.2 × (12% - 5%)=2.2 × 7%=15.4%

The results of regressing y against x are as follows: CoefficientIntercept5.23Slope1.54When the value of x is 10, the estimated value of y is A.20.63 B.53.84 C.6.78 D.8.05

A.20.63Answer (A) is correct. A simple regression can be calculated using the formula for a straight line: y = a + bx Where: y = the dependent variable a = the y-axis intercept b = the slope of the regression line x = the independent variable Solving with the information given yields the following results: y=a + bx=5.23 + (1.54 × 10)=5.23 + 15.4=20.63

The regression analysis results for ABC Co. is shown as y = 90x + 45. The standard error (Sb) is 30 and coefficient of determination (r2) is 0.81. The budget calls for production of 100 units. What is ABC's estimate of total costs? A.$9,045 B.$3,090 C.$9,030 D.$4,590

A.$9,045Answer (A) is correct. ABC Co. can project its total production costs with the simple linear equation y = 90x + 45. The standard error and coefficient of determination are not relevant. Thus, ABC's estimate of total costs is $9,045 [90(100) + 45].

Using regression analysis, Fairfield Co. graphed the following relationship of its cheapest product line's sales with its customers' income levels: Down angle graph If there is a strong statistical relationship between the sales and customers' income levels, which of the following numbers best represents the correlation coefficient for this relationship? A.-0.93 B.+0.93 C.-9.00 D.+9.00

A.-0.93Answer (A) is correct. The coefficient of correlation measures the relative strength of the linear relationship. The range of the coefficient (r) is -1.0 through +1.0. The value of -1.0 indicates a perfectly inverse linear relationship between x and y (i.e., as x increases, y decreases), a value of zero indicates no linear relationship between x and y, and a value of +1.0 indicates a perfectly direct relationship between x and y. Because Fairfield's sales decrease as income levels increase, the inverse linear relationship is very strong. This inverse relationship is best represented by -.93.

If the return on the market portfolio is 10% and the risk-free rate is 5%, what is the effect on a company's required rate of return on its stock of an increase in the beta coefficient from 1.2 to 1.5? A.1.5% increase. B.No change. C.1.5% decrease. D.3% increase.

A.1.5% increase.Answer (A) is correct. The required rate of return on equity capital can be estimated with the capital asset pricing model (CAPM). CAPM consists of adding the risk-free rate (i.e., the return on government securities, denoted RF) to the product of the beta coefficient (a measure of the issuer's risk) and the difference between the market return and the risk-free rate (denoted RM - RF, referred to as the risk premium). Below is the basic equilibrium equation for the CAPM: Required rate of return = RF + β(RM - RF) In this situation, the risk premium is 5% (10% - 5%). Thus, the required rate of return when the beta coefficient is 1.2 is 11% [5% + (1.2 × 5%)], and the required rate when the beta coefficient is 1.5 is 12.5% [5% + (1.5 × 5%)]. This is an increase of 1.5% (12.5% - 11%).

The following information pertains to a company's potential investment in security X:Maturity risk premium1%Liquidity risk premium3%Default risk premium2%Risk-free rate4%What is the company's required rate of return for the investment in this security? A.10% B.9% C.4% D.6%

A.10%Answer (A) is correct. The required rate of return is the return that takes into account all the investment risks that relate to a specific security. Thus, the required rate of return for the investment in security X is 10%.Risk-free rate4%Liquidity risk premium3%Maturity risk premium1%Default risk premium 2%Required rate of return10%

DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ plans to use the following combination of debt and equity to finance the investment.Issue $15 million of 20-year bonds at a price of $101, with a coupon rate of 8%, and flotation costs of 2% of par.Use $35 million of funds generated from earnings.The equity market is expected to earn 12%. U.S. Treasury bonds are currently yielding 5%. The beta coefficient for DQZ is estimated to be .60. DQZ is subject to an effective corporate income tax rate of 40%. Compute DQZ's expected rate of return, under the capital asset pricing model (CAPM). A.9.20% B.12.00% C.12.20% D.7.20%

A.9.20%Answer (A) is correct. The market return (RM), given as 12%, minus the risk-free rate (RF), given as 5%, is the market risk premium. It is the rate at which investors must be compensated to induce them to invest in the market. The beta coefficient (β) of an individual stock, given as .60, is the correlation between volatility (price variation) of the stock market and the volatility of the price of the individual stock. Consequently, the expected rate of return is 9.20% [RF + β (RM - RF) = .05 + .6(.12 - .05)].

Which of the following is not a political risk of investing in a foreign country? A.A foreign customer might default on its debt. B.Assets could be expropriated. C.Rebellions could result in destruction of property. D.Foreign-exchange controls could limit the repatriation of profits.

A.A foreign customer might default on its debt.Answer (A) is correct. Political risks include (1) the threat of expropriation of the firm's assets, (2) destruction of assets in rebellions in third-world nations, and (3) limitations on the repatriation of profits (or even initial investments). Default by a foreign customer is not a political risk, but a risk of doing business either locally or internationally.

The betas and expected returns for three investments being considered by Sky, Inc., are given below.ExpectedInvestmentBetaReturnA1.412%B0.811%C1.513% The return on the market is 11% and the risk-free rate is 6%. If the capital asset pricing model (CAPM) is used for calculating the required rate of return, which investments should the management of Sky make? A.B only. B.B and C only. C.A, B, and C. D.A and C only.

A.B only.Answer (A) is correct. The required rate of return on equity capital can be estimated with the capital asset pricing model (CAPM). CAPM consists of adding the risk-free rate (i.e., the return on government securities, denoted RF) to the product of the beta coefficient (a measure of the issuer's risk) and the difference between the market return and the risk-free rate (denoted RM - RF, referred to as the risk premium). Below is the basic equilibrium equation for the CAPM: Required rate of return = RF + β(RM - RF) The risk premium is 5% (11% - 6%). The CAPM can be thus applied to each of the three investments as follows: Investment A: 6% + (1.4 × 5%) = 13.0% Investment B: 6% + (0.8 × 5%) = 10.0% Investment C: 6% + (1.5 × 5%) = 13.5% These required rates of return can be compared with the expected rates to evaluate which investments should be accepted and which should be rejected.RequiredExpectedRateRateDecision Investment A:13.0%>12%Reject Investment B:10.0%<11% Accept Investment C:13.5%>13% Reject

One type of risk to which investment securities are subject can be offset through portfolio diversification. This type of risk is referred to as A.Company unique risk. B.Market risk. C.Liquidity risk. D.Undiversifiable risk.

A.Company unique risk.Answer (A) is correct. Unsystematic risk, also called company or diversifiable risk, is the risk inherent in a particular investment security. Because individual securities are affected by the particular strengths and weaknesses of the issuer, this risk can be offset through portfolio diversification.

Management utilizes all of the following procedures to develop accounting estimates except A.Excluding uncertainty from assumptions. B.Predicting most likely circumstances and scenarios. C.Identifying circumstances requiring an estimate. D.Presenting estimates in conformity with GAAP.

A.Excluding uncertainty from assumptions.Answer (A) is correct. If uncertainty is excluded from assumptions in the development of estimates, they will not be estimates, they will be factual and the estimation process is not required.

In a regression analysis, the coefficient of determination measures A.Goodness of fit. B.Independence of variables. C.Independence of residuals. D.Economic plausibility.

A.Goodness of fit.Answer (A) is correct. The coefficient of determination (r²), or the coefficient of correlation squared, is a measure of the fit between the independent and dependent variables.

An investment security with high risk will have a(n) A.High standard deviation of returns. B.Low expected return. C.Lower price than an asset with low risk. D.Lower coefficient of variation.

A.High standard deviation of returns.Answer (A) is correct. The greater the standard deviation of the expected return, the riskier the investment. A large standard deviation implies that the range of possible returns is wide; i.e., the probability distribution is broadly dispersed. Conversely, the smaller the standard deviation, the tighter the probability distribution and the lower the risk.

Many assumptions and factors may be considered to determine the fair value except A.Historical cost. B.Net realizable value. C.Expected costs. D.Market value.

A.Historical cost.Answer (A) is correct. Fair value is generally current market value which is independent of historical costs.

Which of the following types of risk can be reduced by diversification? A.Labor strikes. B.Recessions. C.High interest rates. D.Inflation.

A.Labor strikes.Answer (A) is correct. The basic types of investment risk are systematic risk and unsystematic risk. Systematic risk, or market risk, is faced by all firms and cannot be diversified. Unsystematic risk, or unique risk, is the risk inherent in a particular security. A labor strike primarily affects the company experiencing the strike, not the market as a whole. Thus, the risk of a labor strike can be diversified.

The type of risk that is undiversifiable and affects the value of a portfolio is A.Market risk. B.Interest-rate risk. C.Purchasing-power risk .D.Nonmarket risk.

A.Market risk.Answer (A) is correct. Prices of all stocks, even the value of portfolios, are correlated to some degree with broad swings in the stock market. Market risk is the risk that changes in a stock's price will result from changes in the stock market as a whole. Market risk is commonly referred to as undiversifiable risk.

A financial institution looking to assess its investment portfolio's exposure to price changes most likely would use which of the following techniques? A.Market value at risk analysis. B.Cash flow at risk analysis. C.Earnings at risk analysis. D.Backtesting analysis.

A.Market value at risk analysis.Answer (A) is correct. Market value at risk determines the potential decline in market value of a portfolio at a given level of confidence. Thus, the financial institution most likely would use market value at risk analysis to assess its investment portfolio's exposure to price changes.

Because of the large number of factors that could affect the demand for its new product, interactions among these factors, and the probabilities associated with different values of these factors, the marketing department would like to develop a computerized model for projecting demand for this product. By using a random-number procedure to generate values for the different factors, it will be able to estimate the distribution of demand for this new product. This method of estimating the distribution of demand for the new product is called A.Monte Carlo simulation. B.Linear programming. C.Differential analysis. D.Correlation analysis.

A.Monte Carlo simulation.Answer (A) is correct. Simulations that use a random-number procedure to generate values for the inputs are Monte Carlo simulations.

From the viewpoint of the investor, which of the following securities provides the least risk? A.Mortgage bond. B.Debentures. C.Income bond. D.Subordinated debenture.

A.Mortgage bond.Answer (A) is correct. A mortgage bond is secured with specific fixed assets, usually real property. Thus, under the rights enumerated in the bond indenture, creditors will be able to receive payments from liquidation of the property in case of default. In a bankruptcy proceeding, these amounts are paid before any transfers are made to other creditors. Hence, mortgage bonds are less risky than the others listed.

In determining cost behavior in business, the cost function is often expressed as y = a + bx. Which one of the following cost estimation methods should not be used in estimating fixed and variable costs for the equation? A.Multiple regression. B.High and low point method. C.Simple regression. D.Graphic method.

A.Multiple regression.Answer (A) is correct. Regression analysis can be used to find an equation for the linear relationship among variables. However, multiple regression is not used to generate an equation of the type y = a + bx because multiple regression has more than one independent variable. In other words, a multiple regression equation would take the form: y = a + b1x1 + b2x2 + b3x3 + . . . .

The expected rate of return for the stock of Cornhusker Enterprises is 20%, with a standard deviation of 15%. The expected rate of return for the stock of Mustang Associates is 10%, with a standard deviation of 9%. The stock with the worse risk/return relationship is A.Mustang because the coefficient of variation is higher. B.Cornhusker because the standard deviation is higher. C.Cornhusker because the return is higher. D.Mustang because the standard deviation is higher.

A.Mustang because the coefficient of variation is higher.Answer (A) is correct. The coefficient of variation is useful when the rates of return and standard deviations of two investments differ. It measures the risk per unit of return by dividing the standard deviation by the expected return. The coefficient of variation is higher for Mustang (.09 ÷ .10 = .90) than for Cornhusker (.15 ÷ .20 = .75).

In using regression analysis, which measure indicates the extent to which a change in the independent variable explains a change in the dependent variable? A.R-squared. B.p-value. C.t-statistic. D.Standard error.

A.R-squared. Answer (A) is correct. R-squared is also known as the coefficient of determination. It is a measure of how good the fit between the independent and dependent variable is.

If the coefficient of correlation between two variables is zero, how might a scatter diagram of these variables appear? A.Random points. B.A least squares line that slopes up to the right. C.A least squares line that slopes down to the right. D.Under this condition, a scatter diagram could not be plotted on a graph.

A.Random points.Answer (A) is correct. Each observation creates a point that represents x and y values. The collinearity of these relationships and slope of the observations are visible. If the coefficient of correlation is zero, there is no relationship between the variables, and the points will be randomly distributed.

In the standard regression equation y = a + bx, the letter b is best described as a(n) A.Slope of the regression line. B.Independent variable. C.Dependent variable. D.Y intercept.

A.Slope of the regression line.Answer (A) is correct. In the standard regression equation, b represents the slope of the regression line. For example, in a cost determination regression, y equals total costs, b is the variable cost per unit, x is the number of units produced, and a is fixed cost.

To assist in an investment decision, Gift Co. selected the most likely sales volume from several possible outcomes. Which of the following attributes would that selected sales volume reflect? A.The greatest probability. B.The median. C.The expected value. D.The midpoint of the range.

A.The greatest probability.Answer (A) is correct. Probability is important to management decision making because of the uncertainty of future events. Probability estimation techniques assist in making the best decisions in the face of uncertainty. Consequently, the most likely sales volume is the one with the greatest probability.

According to the capital asset pricing model (CAPM), which of the following statements is true regarding the required rate of return for a security with a beta of 1? A.The required rate of return is equal to the market return. B.The required rate of return is equal to the risk-free rate. C.The required rate of return is lower than the risk-free rate. D.The required rate of return is higher than the market return.

A.The required rate of return is equal to the market return.Answer (A) is correct. The CAPM quantifies the required rate of return on a security by relating the security's level of risk to the average return available in the market. When beta equals 1, the required rate of return is equal to the market return, as shown below:Required rate of return=RF + β(RM - RF)=RF + [1 × (RM - RF)]=RF + (RM - RF)=RM

An investor is currently holding income bonds, preferred stocks, subordinated debentures, and U.S. Treasury bonds. Which of these securities traditionally is considered to have the least risk? A.U.S. Treasury bonds. B.Subordinated debentures. C.Preferred stocks. D.Income bonds.

A.U.S. Treasury bonds.Answer (A) is correct. A U.S. Treasury bond is considered to be the highest safety security because it is backed by the full faith and credit of the United States government.

Mat Co. estimated its materials handling costs at two activity levels as follows: Kilos HandledCost80,000$160,00060,000132,000 What is Mat's estimated cost for handling 75,000 kilos? A.$150,000 B.$153,000 C.$165,000 D.$157,500

B.$153,000Answer (B) is correct. The high-low method estimates variable cost by dividing the difference in costs incurred at the highest and lowest observed levels of activity by the difference in activity. Once the variable cost is found, the fixed portion is determinable. Hence, unit variable handling cost is $1.40 [($160,000 - $132,000) ÷ (80,000 kilos - 60,000 kilos)], the fixed cost is $48,000 [$132,000 - (60,000 kilos × $1.40)], and the cost of handling 75,000 kilos is $153,000 [$48,000 + (75,000 kilos × $1.40)].

At the beginning of Year 1, $100,000 is invested at 5% interest, compounded annually. What amount of interest is earned in Year 2? A.$5,512.50 B.$5,250.00 C.$10,000.00 D.$5,000.00

B.$5,250.00Answer (B) is correct. Compounded interest is the practice of adding interest to the carrying amount of the principal rather than disbursing it in cash. The amount of interest earned in Year 1 ($100,000 × 5% = $5,000) was added to the principal, which was then used to calculate the amount of interest earned in Year 2 [($100,000 + $5,000) × 5% = $5,250].

If two projects are completely and positively linearly dependent (or positively related), the measure of correlation between them is A.0 B.+1 C.+.5 D.-1

B.+1Answer (B) is correct. The measure of correlation when two projects are linearly dependent in a positive way is +1.

What coefficient of correlation results from the following data? XY 1 10 2 8 3 6 4 4 5 2 A.0 B.-1 C.Cannot be determined from the data given. D.+1

B.-1Answer (B) is correct. The coefficient of correlation (in standard notation, r) measures the strength of the linear relationship. The magnitude of r is independent of the scales of measurement of X and Y. Its range is -1.0 to 1.0. A value of -1.0 indicates a perfectly inverse linear relationship between X and Y. A value of zero indicates no linear relationship between X and Y. A value of +1.0 indicates a perfectly direct relationship between X and Y. As X increases by 1, Y consistently decreases by 2. Hence, a perfectly inverse relationship exists, and r must be equal to -1.0.

Using the capital asset pricing model (CAPM), the required rate of return for a firm with a beta of 1.5 when the market return is 10% and the risk-free rate is 8% is A.5% B.11% C.10% D.8%

B.11%Answer (B) is correct. The CAPM quantifies the required rate of return on a security by relating the security's level of risk to the average return available in the market. The required rate of return is calculated as follows: Required rate of return=RF + β(RM - RF)=8% + [1.5 × (10% - 8%)]=8% + (1.5 × 2%)=11%

Using the capital asset pricing model (CAPM), the required rate of return for a firm with a beta of 1.25 when the market return is 14% and the risk-free rate is 6% is A.7.5% B.16.0% C.17.5% D.6.0%

B.16.0%Answer (B) is correct. The CAPM adds the risk-free rate to the product of the beta coefficient and the difference between the market return and the risk-free rate. The market-risk premium is the amount above the risk-free rate for which investors must be compensated to induce them to invest in the company. Below is the basic equilibrium equation for the CAPM. Required rate of return = RF + β(RM - RF) Therefore, the beta coefficient of an individual stock is the correlation between volatility (price variation) of the stock market and the volatility of the price of the individual stock. Thus, the required rate is 16% [6% + 1.25 (14% - 6%)].

The following information is available on market interest rates:The risk-free rate of interest2%Inflation premium1%Default risk premium3%Liquidity premium2%Maturity risk premium1%What is the market rate of interest on a 1-year U.S. Treasury bill? A.6% B.3% C.5% D.7%

B.3%Answer (B) is correct. The total return on a U.S. Treasury security consists of the risk-free rate of interest plus an inflation premium. In practice, the safest investment in the world has been U.S. Treasury Securities. While there is some risk in these investments, they have been regarded as the risk-free rate when used in a CAPM analysis. Therefore, the nominal rate of U.S. Treasuries is often used in practice as the risk-free rate in the CAPM analysis.

Konstans Corp. is considering purchasing an investment security with the following information:LikelihoodReturn on Investment50%2%40%4%10%14%The expected return on this investment is A.50% B.4% C.25% D.2%

B.4%Answer (B) is correct. The expected return on this investment is 4% [(50% × 2%) + (40% × 4%) + (10% × 14%)].

Dr. G paid $10,000 for an investment that returned $400. What is the investor's rate of return? A.Cannot be determined without additional information. B.4.0% C.8.0% D.2.5%

B.4.0%Answer (B) is correct. A return is the amount received by an investor as compensation for taking on the risk of the investment. The rate of return is the return stated as a percentage of the amount invested. In this case, it is 4% ($400 ÷ $10,000).

When calculating a company's cost of common stock, an analyst evaluates the following four components: risk-free rate, stock's beta coefficient, rate of return on the market portfolio, and required rate of return on the company's stock. Which of the following measurement models is being used? A.Overall cost of capital. B.Capital asset pricing. C.Weighted marginal cost of capital. D.Constant growth.

B.Capital asset pricing.Answer (B) is correct. The capital asset pricing model (CAPM) quantifies the required return on an equity security by relating the security's level of risk to the average return available in the market (portfolio).The CAPM formula is based on the idea that the investor must be compensated for his or her investment in two ways: the time value of money and risk. The CAPM formula is as follows: Required rate of return = RF + β(RM - RF) Where: RF = Risk-free return, RM = Market return, and β = Stock's beta coefficient.

Catherine & Co. has extra cash at the end of the year and is analyzing the best way to invest the funds. The company should invest in a project only if the A.Return on investments of comparable risk equals the expected return on the project. B.Expected return on the project exceeds the return on investments of comparable risk. C.Return on investments of comparable risk exceeds the expected return on the project. D.Expected return on the project is equal to the return on investments of comparable risk.

B.Expected return on the project exceeds the return on investments of comparable risk.Answer (B) is correct. Investment risk is analyzed in terms of the probability that the actual return on an investment will be lower than the expected return. Comparing a project's expected return with the return on an asset of similar risk helps determine whether the project is worth investing in. If the expected return on a project exceeds the return on an asset of comparable risk, the project should be pursued.

Multiple regression differs from simple regression in that it A.Provides an estimated constant term. B.Has more independent variables. C.Has more dependent variables. D.Allows the computation of the coefficient of determination.

B.Has more independent variables.Answer (B) is correct. Improved accuracy of forecasts may often be achieved by regressing the dependent variable on more than one independent variable. The usual multiple regression equation is linear and is in the following form when y is the dependent variable; a is the y-axis intercept; x1, x2, etc., are the independent variables; b1, b2, etc., are the coefficients of the independent variables; and e is the error term: y = a + b1x1 + b2x2 + ... + e

The letter x in the standard regression equation is best described as a(n) A.Coefficient of determination. B.Independent variable. C.Dependent variable. D.Constant coefficient.

B.Independent variable.Answer (B) is correct. The letter x in the standard regression equation is the independent variable. For example, in a regression to determine the total cost of production, x equals units produced.

Management's financial estimates are based on all of the following except A.Assumptions. B.Known outcomes. C.Knowledge. D.Experience.

B.Known outcomes.Answer (B) is correct. If the outcomes are known, they are not estimates, they are certainties.

Box Co. uses regression analysis to estimate the functional relationship between an independent variable (cost driver) and overhead cost. Assume that the following equation is being used:y = a + bx What is the symbol for the independent variable? A.bx. B.x. C.y. D.a.

B.x.Answer (B) is correct. The simple regression equation is y = a + bx. The symbol y is the dependent variable (overhead costs), a is the y-axis intercept (fixed costs), b is the slope of the regression line (cost driver), and x is the independent variable.

A company experiences both variable usage rates and variable lead times for its inventory items. The probability distributions for both usage and lead times are known. A technique the company could use for determining the optimal safety stock levels for an inventory item is A.Queuing theory. B.Monte Carlo simulation. C.Decision tree analysis. D.Linear programming.

B.Monte Carlo simulation.Answer (B) is correct. Simulation is a method for experimenting with mathematical models using a computer. Monte Carlo simulation generates the individual values for a random variable. A random number generator is used to produce numbers with a uniform probability distribution. The second step of the Monte Carlo process then transforms the random numbers into values consistent with the desired distribution. The performance of a model under conditions of uncertainty may be investigated by randomly selecting values for each of the variables in the model based on the probability distribution of each variable and then calculating the value of the solution. Advantages of Monte Carlo simulation are that time can be compressed, alternative policies can be considered, and complex systems can be analyzed.

For cost estimation, simple regression differs from multiple regression in that simple regression uses only A.Dependent variables, while multiple regression can use both dependent and independent variables. B.One independent variable, while multiple regression uses more than one independent variable. C.One dependent variable, while multiple regression uses more than one dependent variable. D.One dependent variable, while multiple regression uses all available data to estimate the cost function.

B.One independent variable, while multiple regression uses more than one independent variable.Answer (B) is correct. Simple regression uses the algebraic formula for a straight line, y = a + bx, where x is the independent variable. Multiple regression is used when there is more than one independent variable. Multiple regression allows a firm to identify many factors (independent variables) and to weight each one according to its influences on the overall outcome (y = a + b1x1 + b2x2 + b3x3 + etc.).

The coefficient of determination, r squared, in a multiple regression equation is the A.Measure of the proximity of actual data points to the estimated data points. B.Percentage of variation in the dependent variable explained by the variation in the independent variables. C.Coefficient of the independent variable divided by the standard error of the regression coefficient. D.Percentage of variation in the independent variables explained by the variation in the dependent variable.

B.Percentage of variation in the dependent variable explained by the variation in the independent variables.Answer (B) is correct. The coefficient of determination, or the coefficient of correlation squared, measures the fit between the independent and dependent variables. In a multiple regression equation, it is the proportion of the total variation in one dependent variable that is accounted for by two or more independent variables.

If a CPA's client expected a high inflation rate in the future, the CPA would suggest to the client which of the following types of investments? A.Treasury bonds. B.Precious metals. C.Corporate bonds. D.Common stock.

B.Precious metals.Answer (B) is correct. Normally, precious metals are considered a risky investment because their prices are highly volatile. During periods of high inflation, however, currency loses purchasing power rapidly, and precious metals may offer a safe haven to investors.

Through the use of decision models, managers thoroughly analyze many alternatives and decide on the best alternative for the company. Often the actual results achieved from a particular decision are not what was expected when the decision was made. In addition, an alternative that was not selected would have actually been the best decision for the company. The appropriate technique to analyze the alternatives by using expected inputs and altering them before a decision is made is A.Linear programming. B.Sensitivity analysis. C.Expected value analysis. D.Program evaluation review technique (PERT).

B.Sensitivity analysis.Answer (B) is correct. After a problem has been formulated into any mathematical model, it may be subjected to sensitivity analysis. Sensitivity analysis examines how the model's outcomes change as the parameters change.

The risk to which all investment securities are subject is known as A.Diversifiable risk. B.Systematic risk. C.Unsystematic risk. D.Credit risk.

B.Systematic risk.Answer (B) is correct. Systematic risk, also called market risk, is the risk faced by all firms. Changes in the economy as a whole, such as the business cycle, affect all players in the market. For this reason, systematic risk is sometimes referred to as undiversifiable risk. Because all investment securities are affected, this risk cannot be offset through portfolio diversification.

Which of the following classes of securities are listed in order from lowest risk/opportunity for return to highest risk/opportunity for return? A.Common stock; corporate first mortgage bonds; corporate second mortgage bonds; corporate income bonds. B.U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock. C.Preferred stock; common stock; corporate mortgage bonds; corporate debentures. D.Corporate income bonds; corporate mortgage bonds; convertible preferred stock; subordinated debentures.

B.U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock.Answer (B) is correct. The general principle is that risk and return are directly correlated. U.S. Treasury securities are backed by the full faith and credit of the federal government and are therefore the least risky form of investment. However, their return is correspondingly lower. Corporate first mortgage bonds are less risky than income bonds or stock because they are secured by specific property. In the event of default, the bondholders can have the property sold to satisfy their claims. Holders of first mortgages have rights paramount to those of any other parties, such as holders of second mortgages. Income bonds pay interest only in the event the corporation earns income. Thus, holders of income bonds have less risk than shareholders because meeting the condition makes payment of interest mandatory. Preferred shareholders receive dividends only if they are declared, and the directors usually have complete discretion in this matter. Additionally, shareholders have claims junior to those of debtholders if the enterprise is liquidated.

The marketable securities with the least amount of default risk are A.Federal government agency securities. B.U.S. Treasury securities. C.Commercial paper. D.Repurchase agreements.

B.U.S. Treasury securities.Answer (B) is correct. The marketable securities with the lowest default risk are those issued by the federal government. They are backed by the full faith and credit of the U.S. government and therefore are the least risky form of investment.

Multiple regression analysis involves the use of Dependent VariablesIndependent Variables A. Dependent Variables More than one Independent Variables More than one B. Dependent Variables One Independent Variables One C. Dependent Variables One Independent Variables More than one D. Dependent Variables More than one Independent Variables One

C. Dependent Variables One Independent Variables More than one Answer (C) is correct. Improved accuracy of forecasts may often be achieved by regressing the dependent variable on more than one independent variable. The usual multiple regression equation is linear and is in the following form: y = a + bx1 + bx2 + ... + e

Jackson Co. has the following information for the first 4 months of this year: Machine Cleaning HoursbExpense January 2,100 $ 900 February 2,600 1,200 March 1,600 800 April 2,000 1,000 Using the high-low method, what is Jackson's variable cost of cleaning per machine hour? A.$2.50 B.$2.00 C.$.40 D.$.48

C.$.40Answer (C) is correct. The high-low method is used to generate a regression line by basing the equation on only the highest and lowest of a series of observations. In this problem, March was the lowest and February the highest.February$1,200for2,600hoursMarch(800)for(1,600)hoursIncrease$ 400for1,000hours Thus, it costs $400 for 1,000 hours, or $.40 for an hour.

Beginning January 2, Year 1, a company deposited $50,000 in a savings account for 2 years. The account earns 10% interest, compounded annually. What amount of interest did the company earn during the 2-year period? A.$10,000 B.$5,500 C.$10,500 D.$5,000

C.$10,500Answer (C) is correct. Compounding interest is the practice of adding interest to the carrying amount of the principal rather than paying it in cash. The amount of interest earned in Year 1 ($50,000 × 10% = $5,000) was added to the principal, which was then used to calculate the amount of interest earned in Year 2 [($50,000 + $5,000) × 10% = $5,500]. The total amount of interest earned during the 2-year period was thus $10,500 ($5,000 Year 1 + $5,500 Year 2). This amount also can be calculated as follows: [($50,000 × 1.1 × 1.1) - $50,000].

In order to analyze sales as a function of advertising expenses, the sales manager of Smith Company developed a simple regression model. The model included the following equation, which was based on 32 monthly observations of sales and advertising expenses with a related coefficient of determination of .90. Sales = $10,000 + (2.5 × Advertising expenses) If Smith Company's advertising expenses in 1 month amounted to $1,000, the related point estimate of sales would be A.$12,250 B.$11,250 C.$12,500 D.$2,500

C.$12,500Answer (C) is correct. The simple regression equation can be solved as follows: Sales=$10,000 + (2.5 × Advertising expenses)=$10,000 + (2.5 × $1,000)=$10,000 + $2,500=$12,500

Jackson Co. has the following information for the first 4 months of this year: Machine Cleaning Hours Expense January 2,100 $ 900 February 2,600 1,200 March 1,600 800 April 2,000 1,000 Using the high-low method, what is Jackson's fixed cost? A.$320 B.$640 C.$160 D.$1,040

C.$160Answer (C) is correct. The high-low method generates a regression equation using only the high-cost month and low-cost month. The variable cost per machine hour is therefore $.40 [($1,200 - $800) ÷ (2,600 hours - 1,600 hours)] for either the high-cost (February) or low-cost (March) month. The fixed costs are calculated as follows:Total cost in February$1,200Minus: Variable cost (2,600 hours × $.40)(1,040)Fixed cost$ 160

Day Mail Order Co. applied the high-low method of cost estimation to customer order data for the first 4 months of the current year. What is the estimated variable order-filling cost component per order? No. ofMonthOrdersCostJanuary1,200$ 3,120February1,3003,185March1,8004,320April1,7003,895 6,000$14,520 A.$2.48 B.$2.50 C.$2.00 D.$2.42

C.$2.00Answer (C) is correct. The high-low method estimates unit variable cost by dividing the difference in costs at the highest and lowest levels of activity by the differences in activity. The difference between the highest and lowest amounts of orders was 600 (1,800 - 1,200). Given a cost differential of $1,200 ($4,320 - $3,120), the estimated unit variable cost is $2.00 ($1,200 ÷ 600).

In preparing the annual profit plan for the coming year, Fine Company wants to determine the cost behavior pattern of the maintenance costs. Fine has decided to use linear regression by employing the equation y = a + bx for maintenance costs. The results of the regression analysis are given below.a684.65b7.2884Based upon the data derived from the regression analysis, 420 maintenance hours in a month would mean that Fine Co.'s maintenance costs (rounded to the nearest dollar) would be budgeted at A.$3,790 B.$3,600 C.$3,746 D.$3,780

C.$3,746Answer (C) is correct. Substituting the given data into the regression equation results in a budgeted cost of $3,746 (rounded to the nearest dollar).y=a + bxy=684.65 + 7.2884(420)y=$3,746

Cook Co.'s total costs of operating five sales offices last year were $500,000, of which $70,000 represented fixed costs. Cook has determined that total costs are significantly influenced by the number of sales offices operated. Last year's costs and number of sales offices can be used as the bases for predicting annual costs. What would be the budgeted cost for the coming year if Cook were to operate seven sales offices? A.$602,000 B.$586,000 C.$672,000 D.$700,000

C.$672,000Answer (C) is correct. Using the formula y = a + bx, y is the total budgeted cost, a is the fixed costs, b is the variable cost per unit, and x is the number of budgeted sales offices. The fixed costs are $70,000, the variable cost per unit is $86,000 [($500,000 - $70,000) ÷ 5], and the number of budgeted sales offices is 7. Thus, the budgeted cost for the coming year assuming seven sales offices is $672,000 [$70,000 + (7 × $86,000)].

At the beginning of Year 1, $10,000 is invested at 8% interest, compounded annually. What amount of interest is earned for Year 2? A.$800.00 B.$933.12 C.$864.00 D.$806.40

C.$864.00Answer (C) is correct. Compounded interest is the practice of adding interest to the carrying amount of the principal rather than disbursing it in cash. In this case, the $800 ($10,000 principal × 8% stated rate) of interest earned in Year 1 is added to the principal, resulting in a Year 1 ending balance of $10,800 ($10,000 + $800). Interest earned in Year 2 is therefore $864 ($10,800 principal × 8% stated rate).

In regression analysis, which of the following coefficients of correlation represents the strongest linear relationship between the independent and dependent variables? A.0.75 B.1.03 C.-0.89 D.-0.02

C.-0.89Answer (C) is correct. A coefficient of -1.0 signifies a perfect inverse relationship, and a coefficient of 1.0 signifies a perfect direct relationship. Thus, the higher the absolute value of the coefficient of correlation, the stronger the linear relationship. A coefficient of -0.89 suggests a very strong inverse relationship between the independent and dependent variables.

In theory, which of the following coefficients of correlation would eliminate unsystematic risk in an investment portfolio? A.1.0 B.No theoretical coefficient exists for the elimination of risk in a portfolio context. C.-1.0 D.0.0

C.-1.0Answer (C) is correct. The correlation coefficient measures the degree to which any two variables, e.g., two stocks in a portfolio, are related. Perfect negative correlation (-1.0) means that the two variables always move in the opposite direction. Given perfect negative correlation, unsystematic risk is, in theory, eliminated.

Stock X has a beta of 1.6 and a required rate of return of 14%. Consistent with the capital asset pricing model (CAPM), what is the expected return on the market if the risk-free rate is equal to 6%? A.19% B.20% C.11% D.2.75%

C.11%Answer (C) is correct. The CAPM quantifies the required rate of return on a security by relating the security's level of risk to the average return available in the market. The market return (RM) can be derived from the CAPM equation as follows: Required rate of return=RF + β(RM - RF)14% =6% + [1.6 × (RM - 6%)]14%=6% + (1.6 RM - 9.6%) 1.6RM=17.6% RM=11%

City Development, Inc., is considering a new investment project that will involve building a large office block in Frankfurt-am-Main. The firm's financial analysis department has estimated that the proposed investment has the following estimated rate of return distributions:Rate of ReturnProbability(5%)30%10%50%20%20%Calculate the expected rate of return. A.11.7% B.5.5% C.7.5% D.10.5%

C.7.5%Answer (C) is correct. The expected rate of return on an investment can be calculated by weighting each potential rate of return by its probability of occurrence and summing the results. City Development's expected rate of return for this development is:ExpectedRate ofRate ofReturnProbabilityReturn(5.0)%30.0%(1.5)%10.0%50.0%5.0%20.0%20.0%4.0%7.5%

State of the Economy Probability Techspace Returns Recession .35 -10% Stable .40 10% Expansion .25 30% What is the expected rate of return on Techspace, Inc., stock? A.15% B.10% C.8% D.30%

C.8%Answer (C) is correct. The expected rate of return on an investment is the sum of the weighted averages of the possible outcomes weighted by their probabilities. For Techspace, the computation is performed as follows:PossibleRate ofWeightedState of the EconomyReturnProbabilityAveragesRecession(10)%×35%=(3.5)%Stable10%×40%=4.0%Expansion30%×25%=7.5% Expected rate of return8.0%

Overhead costs have not been established for the new product, but monthly data on total production and overhead cost for the past 24 months have been analyzed using simple linear regression. The results below were derived from the simple regression and provide the basis for overhead cost estimates for the new product: Dependent variable (y) -- Factory overhead costs Independent variable (x) -- Direct labor hours Computed values: y intercept $40,000 Coefficient of independent variable $2.10 Coefficient of correlation 0.953 Standard error of estimate $2,840 Standard error of regression coefficient 0.42 Mean value of independent variable $18,000 Coefficient of determination 0.908 What percentage of the variation in Alpha's overhead costs is explained by the independent variable? A.42% B.95.3% C.90.8% D.48.8%

C.90.8%Answer (C) is correct. The coefficient of determination (r2) is the square of the coefficient of correlation (r). The coefficient of determination may be interpreted as the percent of variation in the dependent variable "explained" by the variation in the independent variable. Here, r = 0.953, and r2 = 0.908. Thus, 90.8% of the variation in overhead costs can be explained by direct labor hours.

Probability (risk) analysis is A.Used only for situations involving five or fewer possible outcomes. B.Used only for situations in which the summation of probability weights is less than one. C.An extension of sensitivity analysis. D.Incompatible with sensitivity analysis.

C.An extension of sensitivity analysis.Answer (C) is correct. Probability (risk) analysis is used to examine the array of possible outcomes given alternative parameters. Sensitivity analysis answers what-if questions when alternative parameters are changed. Thus, risk (probability) analysis is similar to sensitivity analysis: both evaluate the probabilities and effects of differing inputs or outputs.

A measure that describes the risk of an investment project relative to other investments in general is the A.Coefficient of variation. B.Expected return. C.Beta coefficient. D.Standard deviation.

C.Beta coefficient.Answer (C) is correct. The required rate of return on equity capital in the capital asset pricing model is the risk-free rate (determined by government securities), plus the product of the market risk premium times the beta coefficient (beta measures the firm's risk). The market risk premium is the amount above the risk-free rate that will induce investment in the market. The beta coefficient of an individual stock is the correlation between the volatility (price variation) of the stock market and that of the price of the individual stock.

Management utilizes all of the following procedures to develop accounting estimates except A.Understanding factors affecting the situation. B.Predicting the most likely circumstances and scenarios. C.Emphasizing historical experience. D.Identifying circumstances requiring an estimate.

C.Emphasizing historical experience.Answer (C) is correct. Management does not emphasize historical experience when making an accounting estimate. History is factual and the estimation process is not required.

A regression equation A.Is based on objective and constraint functions. B.Encompasses factors outside the relevant range. C.Estimates the dependent variable(s). D.Estimates the independent variable.

C.Estimates the dependent variable(s).Answer (C) is correct. Regression analysis is used to find an equation for the linear relationship among variables. The behavior of the dependent variable is explained in terms of one or more independent variables. Regression analysis is often used to estimate a dependent variable (such as cost) given a known independent variable (such as production).

Prior to the introduction of the euro, O&B Company, a U.S. corporation, is in possession of accounts receivable denominated in Deutsche marks. To what type of risk are they exposed? A.Liquidity risk. B.Political risk. C.Exchange-rate risk. D.Price risk.

C.Exchange-rate risk.Answer (C) is correct. Exchange-rate risk is the risk that a foreign currency transaction will be negatively exposed to fluctuations in exchange rates. Because O&B Company sells goods to German customers and records accounts receivable denominated in Deutsche marks, O&B Company is exposed to exchange-rate risk.

Which tool would most likely be used to determine the best course of action under conditions of uncertainty? A.Program evaluation and review technique (PERT). B.Cost-volume-profit analysis. C.Expected value (EV). D.Scattergraph method.

C.Expected value (EV).Answer (C) is correct. Expected value analysis provides a rational means for selecting the best alternative in decisions involving risk. The expected value of an alternative is found by multiplying the probability of each outcome by its payoff and summing the products. It represents the long-term average payoff for repeated trials.

Which of the following is most useful when risk is being prioritized? A.Low- and high-degree loss exposures. B.Low- and high-probability exposures. C.Expected value. D.Uncontrollable risks.

C.Expected value. Answer (C) is correct. Expected value is the predicted value for a given investment. Expected value is derived by multiplying each possible outcome by the likelihood that each outcome will occur and summing the results. Through this analysis, investors can choose the scenario that is most likely to give them their desired outcome.

Correlation is a term frequently used in conjunction with regression analysis and is measured by the value of the coefficient of correlation, r. The best explanation of the value r is that it A.Is always positive. B.Interprets variances in terms of the independent variable. C.Is a measure of the relative relationship between two variables. D.Ranges in size from negative infinity to positive infinity.

C.Is a measure of the relative relationship between two variables.Answer (C) is correct. The coefficient of correlation (r) measures the strength of the linear relationship between the dependent and independent variables. The magnitude of r is independent of the scales of measurement of x and y. The coefficient lies between -1.0 and +1.0. A value of zero indicates no linear relationship between the x and y variables. A value of +1.0 indicates a perfectly direct relationship, and a value of -1.0 indicates a perfectly inverse relationship.

The risk that securities cannot be sold at a reasonable price on short notice is called A.Purchasing-power risk. B.Interest-rate risk. C.Liquidity risk. D.Default risk.

C.Liquidity risk.Answer (C) is correct. An asset is liquid if it can be converted to cash on short notice. Liquidity (marketability) risk is the risk that assets cannot be sold at a reasonable price on short notice. If an asset is not liquid, investors will require a higher return than for a liquid asset. The difference is the liquidity premium.

An investor is considering the purchase of one of two common stocks. The projected returns for the two stocks and the probabilities for each are listed below: Marcel Company Stock Gilberte Company Stock Rate of Rate of Return Probability Return Probability 6.0 % 10% 7.0 % 25% 4.0 % 40% 5.0 % 25% 2.0 % 40% 0.0 % 25% (2.0)% 10% (1.0)% 25% Based on an expected rate of return calculation, which stock should the investor purchase? A.Gilberte Company's, because its expected rate of return is slightly higher. B.Marcel Company's, because its weighted downside risk is lower. C.Marcel Company's, because its expected rate of return is slightly higher. D.Gilberte Company's, because its weighted upside risk is higher.

C.Marcel Company's, because its expected rate of return is slightly higher.Answer (C) is correct. The expected rates of return for the two stocks can be arrived at using a weighted-average calculation, as follows: Marcel Company StockGilberte Company StockRate ofWeightedRate ofWeightedReturnProbabilityAveragesReturnProbabilityAverages 6.0 %×10%=0.60 % 7.0 %×25%=1.75 % 4.0 %×40%=1.60 % 5.0 %×25%=1.25 % 2.0 %×40%=0.80 % 0.0 %×25%=0.00 %(2.0)%×10%=(0.20)%(1.0)%×25%=(0.25)%Expected rate of return2.80 %Expected rate of return2.75 %

Management should obtain and evaluate sufficient appropriate data to support significant accounting estimates. Differences between the estimates best supported by the data and those in the financial statements A.Should arouse concern only when estimates are based on hypothetical assumptions or subjective factors. B.Are per se unreasonable and should be treated as material misstatements. C.May be individually reasonable but collectively indicate possible bias. D.May be individually unreasonable, but if they collectively indicate no bias, accumulation of the differences with other identified misstatements is not required.

C.May be individually reasonable but collectively indicate possible bias.Answer (C) is correct. If the amount in the financial statements is not reasonable, it should be treated as fraud or error and accumulated with other identified misstatements. If the differences between the best estimates and those in the financial statements are individually reasonable but collectively indicate possible bias (for example, when the effect of each difference is to increase income), the auditor should reconsider the estimates as a whole.

Which of the following may be used to estimate how inventory warehouse costs are affected by both the number of shipments and the weight of materials handled? A.Probability analysis. B.Economic order quantity analysis. C.Multiple regression analysis. D.Correlation analysis.

C.Multiple regression analysis.Answer (C) is correct. Multiple regression analysis involves the use of a linear equation. This equation consists of one dependent variable and more than one independent variable. Accordingly, estimating inventory warehouse costs involves both a dependent variable and independent variables. Hence, multiple regression should be used to estimate these costs.

Management's financial estimates are based on all of the following except A.Assumptions. B.Experience. C.Prespecifications. D.Knowledge.

C.Prespecifications.Answer (C) is correct. Management judgment is the basis for accounting estimates and includes the knowledge of and experience gained during current and past events, but not prespecifications of future events. If they were prespecified and known, they would not be estimates.

Management utilizes all of the following procedures to develop accounting estimates except A.Understanding factors affecting the study. B.Identifying circumstances requiring an estimate. C.Quantifying confidence in the estimate. D.Predicting the most likely circumstances and scenarios.

C.Quantifying confidence in the estimate.Answer (C) is correct. Quantification of the confidence in estimates is not presented in financial statements. Only the accounting estimates and disclosure of the underlying assumptions and circumstances are presented. The quantification is not needed.

A widely used approach that managers use to recognize uncertainty about individual items and to obtain an immediate financial estimate of the consequences of possible prediction errors is A.Expected value analysis. B.Regression analysis. C.Sensitivity analysis. D.Learning curve analysis.

C.Sensitivity analysis.Answer (C) is correct. After a problem has been formulated into any mathematical model, it may be subjected to sensitivity analysis. Sensitivity analysis examines how the model's outcomes change as the parameters change.

To help assure the reasonableness of an entity's accounting estimates, management probably is concerned about assumptions that are A.Consistent with prior periods. B.Insensitive to variations. C.Susceptible to bias. D.Similar to industry guidelines.

C.Susceptible to bias.Answer (C) is correct. In evaluating the reasonableness of an estimate, the management normally concentrates on key factors and assumptions that are (1) significant to the accounting estimate, (2) sensitive to variations, (3) deviations from historical patterns, and (4) subjective and susceptible to misstatement and bias.

A management accountant performs a linear regression of maintenance cost vs. production using a computer spreadsheet. The regression output shows an "intercept" value of $322,897. How should the accountant interpret this information? A.The residual error of the regression is $322,897. B.The value of x is $322,897 when y equals zero. C.The value of y is $322,897 when x equals zero. D.Maintenance cost has an average value of $322,897.

C.The value of y is $322,897 when x equals zero.Answer (C) is correct. In the simple regression equation y = a + bx + e, y is the dependent variable, a is the y-axis intercept (the fixed cost in a cost function), b is the slope of the regression line (the variable cost in a cost function), x is the independent variable, and e is the error term. The total cost of maintenance is a dependent variable because it will change as the production (i.e., the independent variable) changes. Thus, when production (x, the independent variable) is zero, the total cost of maintenance (y, the dependent variable) is equal to fixed cost.

An accountant has been retained by a company as an investment advisor for its employees. Research of historical rates of return yields the following information:Type of InvestmentMean ReturnStandard DeviationCommon stocks12%20%Long-term corporate bonds6%8%Intermediate-term government bonds5%5%U.S. Treasury bills4%3%Which of the following investments has the optimal risk-return tradeoff if a return's standard deviation is an accurate assessment of investment risk? A.Common stocks. B.Long-term corporate bonds. C.U.S. Treasury bills. D.Intermediate-term government bonds.

C.U.S. Treasury bills.Answer (C) is correct. The coefficient of variation (standard deviation ÷ expected rate of return) is useful when the rates of return and standard deviation of two investments differ. It measures the risk per unit of return. The lower the ratio, the better the risk-return tradeoff. The coefficient of variation for U.S. Treasury bills is .75 (.03 ÷ .04). This is the lowest ratio of the four securities, providing the optimal risk-return tradeoff.

When making fair value estimates and disclosures, management most likely should A.Emphasize internal control over understanding of the entity's process for determining fair value estimates. B.Focus primarily on the initial recording of transactions. C.Understand the entity's process for determining fair value estimates to assess the risks of material misstatement. D.Determine fair value estimates using discounted cash flows whenever feasible.

C.Understand the entity's process for determining fair value estimates to assess the risks of material misstatement.Answer (C) is correct. When making fair value estimates included in the financial statements, management must adopt financial reporting processes that include (1) adequate internal control, (2) selecting appropriate accounting policies, (3) prescribing estimation processes (e.g., valuation methods, including models), (4) determining data and assumptions, (5) reviewing the circumstances requiring estimation, and (6) making necessary reestimates. The understanding is used to assess the risks of material misstatement. Assessing these risks includes evaluating (1) estimation uncertainty (inherent lack of measurement precision) and (2) determining whether the risks are significant.

A U.S. company currently has domestic operations only. It is considering an equal-size investment in either Canada or Britain. The data on expected rate of return and the risk associated with each of these proposed investments are given below.Proposed InvestmentExpected Rate of ReturnStandard DeviationBritish Investment22%10%Canadian Investment28%15% The expected rate of return on the company's current, domestic only, business is 20% with a standard deviation of 15%. Using the above data and the correlation coefficients, the company calculated the following portfolio risk and return (based on a ratio of 50% U.S. domestic operations and 50% international operations).Proposed InvestmentExpected Rate of ReturnStandard DeviationU.S. and Britain21%3%U.S. and Canada24%15% The company plans to select the optimal combination of countries based on risk and return for the domestic and international investments taken together. Because the company is new to the international business environment, it is relatively risk averse. Based on the above data, which one of the following alternatives provides the best risk-adjusted return to the firm? A.Unable to determine based on data given. B.Do not undertake either investment. C.Undertake the British investment. D.Undertake the Canadian investment.

C.Undertake the British investment.Answer (C) is correct. A risk-averse company will select the investment with the lower risk per unit of return. Thus, by choosing to invest in Britain, the risk per unit of return is the lowest of all the options mentioned, and it is equal to 0.1428 = 3% ÷ 21%.

The risk of a single stock is A.Portfolio risk. B.Market risk. C.Unsystematic risk. D.Interest rate risk.

C.Unsystematic risk.Answer (C) is correct. Unsystematic risk is the risk of a single stock, but portfolio risk is the net risk of holding a portfolio of diversified securities. Portfolio risk therefore includes systematic and unsystematic risk.

Roger Co. implemented activity-based costing in the current year. To select the appropriate driver for Cost Pool A, Roger performed regression analyses for two independent variables, Driver 1 and Driver 2, using monthly operating data. The monthly levels of Cost Pool A were the dependent variables in both regressions. Output results from the regression analyses were as follows:Driver 1Driver 2R squared 0.46 0.80Intercept$551.00$970.00X variable (slope) $0.55 $0.33At the budgeted production level for next month, the levels of Driver 1 and Driver 2 are expected to be 5,880 and 7,000, respectively. Based on this information, what is the budgeted amount for Cost Pool A for next month? A.$3,785 B.$3,464 C.$2,624 D.$3,280

D.$3,280Answer (D) is correct. The coefficient of determination, also known as R squared, is a measure of fit between the independent and dependent variable(s).The closer the coefficient is to 1.0, the more useful the independent variable is in explaining or predicting the variation in the dependent variable. Accordingly, Driver 2 is more useful in predicting the cost behavior of Cost Pool A. Using the information provided, the regression equation for Driver 2 can be derived to be y = $0.33X + $970 X equals the expected production levels of Driver 2, and y equals the total expected cost. Given an expected monthly production level of 7,000 for Driver 2, the total expected costs are $3,280 [($0.33 × 7,000) + $970].

January 2,100 $ 900 February 2,600 1,200 March 1,600 800 April 2,000 1,000 Jackson's management expects machine hours for the month of May to be 1,400 hours. What is their expected total cost for the month of May using the high-low method? A.$760 B.$650 C.$560 D.$720

D.$720Answer (D) is correct. The expected total cost, using the high-low method, can be found as follows: First, calculate the variable cost per machine hour. ($1,200 - $800) ÷ (2,600 hours - 1,600 hours) = $.40 Then, using the data from February (or March), calculate the expected fixed costs. Total cost $1,200 Minus: Variable cost (2,600 hours × $.40) (1,040) Fixed cost $ 160 Finally, calculate the expected total cost. Expected total cost = Expected fixed cost + Expected variable cost = $160 + (1,400 hours × $.40 per hour) = $160 + $560 = $720

The coefficient of correlation that indicates the weakest linear association between two variables is A.0.12 B.0.35 C.-0.73 D.-0.11

D.-0.11Answer (D) is correct. The coefficient of correlation can vary from -1 to +1. A -1 coefficient indicates a perfect negative correlation, and a +1 coefficient indicates a perfect positive correlation. A zero coefficient of correlation indicates no linear association between the variables. Thus, the coefficient of correlation that is nearest to zero indicates the weakest linear association. Of the options given in the question, the correlation coefficient that is nearest to zero is -0.11.

Given that the standard deviation (σ) of Techspace returns is 15.36% and the expected rate of return is 8%, the coefficient of variation is A.1.0 B.2.36 C.1.23 D.1.92

D.1.92Answer (D) is correct. The coefficient of variation is useful when the rates of return and standard deviations of two investments differ. It measures the risk per unit of return. Techspace's is calculated as follows: Coefficient of variation = standard deviation/expected rate of return 15.36% ÷ 8% = 1.92

The common stock of Wisconsin's Finest Cheese has a beta coefficient of 1.7. The following information about overall market conditions is available:Expected return on U.S. Treasury bonds6%Expected return on the market portfolio8.5%Using the capital asset pricing model (CAPM), what is the risk premium on the market? A.10.3% B.4.3% C.1.7% D.2.5%

D.2.5%Answer (D) is correct. The risk premium on the market is the return on the market portfolio (8.5%) minus the risk-free return as measured by the return on U.S. Treasury securities (6%), or 2.5%.

Stock M has a beta of 1.2 and a required rate of return of 10%. Consistent with the capital asset pricing model (CAPM), what is the risk-free rate of return if the market rate of return is equal to 9%? A.0.67% B.8.17% C.9.45% D.4%

D.4%Answer (D) is correct. The CAPM quantifies the required rate of return on a security by relating the security's level of risk to the average return available in the market. The risk-free rate of return (RF) can be derived from the CAPM equation as follows:Required rate of return=RF + β(RM - RF)10%=RF + [1.2(9% - RF)]10%=RF + 10.8% - 1.2RF0.2RF=0.8%RF=4%

A company is evaluating its experience with five recent investments. The following data are available:Cost ofAmountInvestmentInvestmentReceivedA$ 8,500$ 8,390B4,2004,610C12,10012,400D7,9008,220E11,00011,400Rank the investments in order from highest rate of return to lowest. A.B, E, D, C, A. B.C, E, A, D, B. C.A, C, E, D, B. D.B, D, E, C, A.

D.B, D, E, C, A.Answer (D) is correct. Rate of return is equal to the return on an investment (the amount received minus the amount invested) divided by the amount invested. The calculation for these five investments can be performed as follows: Cost ofAmountRate ofInvestmentInvestmentReceivedReturnReturnA$ 8,500$ 8,390$(110)(1.3%)B4,2004,6104109.8%C12,10012,4003002.5%D7,9008,2203204.1%E11,00011,4004003.6%

The reasonableness of management's accounting estimates A.Will be unfavorable if the estimates in the financial statements are based on assumptions about future events and transactions. B.Should be in the context of individual transactions. C.Should be based on an attitude of conservatism. D.Considers that management bases its judgment on both subjective and objective factors.

D.Considers that management bases its judgment on both subjective and objective factors.Answer (D) is correct. Estimates are based on both subjective and objective factors. Thus, control over estimates may be difficult to establish. Given the potential bias in the subjective factors, the auditor should adopt an attitude of professional skepticism toward both the subjective and objective factors.

To estimate the NRV of the inventory, management will probably consider the following sources except A.Estimated costs of disposal. B.The estimated costs of completion. C.Expected selling prices of the inventory. D.Costs incurred to date.

D.Costs incurred to date.Answer (D) is correct. Costs incurred to date are generally not relevant to future selling prices of the completed inventory.

Global companies that deal with the political and financial risks of conducting business in a particular foreign location face which of the following types of risk? A.Interest rate risk. B.Principal risk. C.Commodity price risk. D.Country risk.

D.Country risk.Answer (D) is correct. Country risk is defined as the risks that are associated with investing in or conducting business in a specific foreign country. These types of risks could include both political and economic risk.

Which of the following forecasting methods relies mostly on judgment? A.Regression. B.Econometric models. C.Time series models. D.Delphi.

D.Delphi.Answer (D) is correct. The Delphi technique was developed by the RAND Corporation in the late 1960s as a forecasting methodology. Later, the U.S. government enhanced it as a group decision-making tool with the results of Project HINDSIGHT, which established a factual basis for the workability of Delphi. That project produced a tool in which a group of experts could reach a consensus when the decisive factors were subjective, not knowledge-based.

Which of the following factors would not be relevant when determining the risk premium on a specific security? A.Relative seniority. B.Length of maturity. C.Relative liquidity. D.Earnings per share.

D.Earnings per share.Answer (D) is correct. The greater the risk of the investment, the higher the rate of return required by the investor. For each type of investment risk, the investor requires an additional risk premium that compensates him or her for bearing that risk. The earnings per share of the security is not a factor that can increase or decrease the riskiness of an investment and therefore would not be relevant when determining the risk premium on a specific security.

The risk of loss because of fluctuations in the relative value of foreign currencies is called A.Expropriation risk. B.Undiversifiable risk. C.Multinational beta. D.Exchange rate risk.

D.Exchange rate risk.Answer (D) is correct. When amounts to be paid or received are denominated in a foreign currency, exchange rate fluctuations may result in exchange gains or losses. For example, if a U.S. firm has a receivable fixed in terms of units of a foreign currency, a decline in the value of that currency relative to the U.S. dollar results in a foreign exchange loss.

An analysis of a company's planned equity financing using the Capital Asset Pricing Model (or Security Market Line) incorporates only the A.Expected market earnings and the price-earnings ratio. B.Risk-free rate, the price-earnings ratio, and the beta coefficient. C.Risk-free rate and the dividend payout ratio. D.Expected market earnings, the risk-free rate, and the beta coefficient.

D.Expected market earnings, the risk-free rate, and the beta coefficient.Answer (D) is correct. The capital asset pricing model adds the risk-free rate to the product of the market risk premium and the beta coefficient. The market risk premium is the amount above the risk-free rate (approximated by the U.S. treasury bond yield) that must be paid to induce investment in the market. The beta coefficient of an individual stock is the correlation between the price volatility of the stock market as a whole and the price volatility of the individual stock.

If Dexter Industries has a beta value of 1.0, then its A.Return should equal the risk-free rate. B.Volatility is low. C.Price is relatively stable. D.Expected return should approximate the overall market.

D.Expected return should approximate the overall market.Answer (D) is correct. The effect of an individual security on the volatility of a portfolio is measured by its sensitivity to movements by the overall market. This sensitivity is stated in terms of a stock's beta coefficient. If the beta coefficient is 1.0, the price of that stock tends to move in the same direction and to the same degree as the overall market. The expected return can be calculated from the CAPM model formula.Expected return=RF + β(RM - RF)RF=Risk-free rateRM=Market returnWhen β = 1, expected return is equal to the market return.

Standard deviation and expected return information for four investments selling for the same price is as follows:InvestmentStandard DeviationExpected ReturnA25%20%B20%18%C12%8%D10%10%What investment is the best choice in terms of the risk/return relationship? A.Investment B. B.Investment A. C.Investment C. D.Investment D.

D.Investment D.Answer (D) is correct. The coefficient of variation is useful when the rates of return and standard deviations of two investments differ. It measures the risk per unit of return because it divides the standard deviation by the expected return. Thus, the risk per unit of return for Investment D is 1.00 (.10 ÷ .10), which is the lowest of the given investments.

Russell, Inc., is evaluating four independent investment proposals. The expected returns and standard deviations for each of these proposals are presented below.InvestmentExpectedStandardProposalReturnsDeviationI16%10%II14%10%III20%11%IV22%15%Which one of the investment proposals has the least risk per unit of return? A.Investment I. B.Investment IV. C.Investment II. D.Investment III.

D.Investment III.Answer (D) is correct. The coefficient of variation (CV) measures the risk per unit of return by dividing the standard deviation (σ) by the expected return. The investment with the lowest CV has the best risk-return tradeoff. The CVs of Russell's four investment proposals can thus be calculated as follows:Standard Expected Coefficient Deviation Returns of Variation Investment I 10%÷16%=62.5% Investment II 10%÷14%=71.4% Investment III 11%÷20%=55.0% Investment IV 15%÷22%=68.2%

An entity is examining potential investments and notes that 1-year maturity yields are higher than those for 10-year maturities. Which of the following explanations for this occurrence is best? A.The long-term instruments provide a longer stream of investment income and therefore carry a lower rate of return. B.The short-term investments have higher liquidity and therefore carry a higher rate of interest. C.The short-term investments carry a more immediate default risk premium resulting in higher rates of return. D.Investors are expecting reduced inflation in the future as reflected in the lower long-term returns.

D.Investors are expecting reduced inflation in the future as reflected in the lower long-term returns.Answer (D) is correct. Inflation risk is the risk that purchasing power will be lost while the loan is at the borrower's disposal. If inflation is expected to be lower in the future, investors are willing to accept a lower yield because overall purchasing power will be increased in later periods due to expected reduced inflation.

Management's financial estimates are based on all of the following except: A.Expectations. B.Knowledge. C.Experience. D.Irrelevance.

D.Irrelevance. Answer (D) is correct. Management will only base estimates on relevant information.

When purchasing temporary investments, which one of the following best describes the risk associated with the ability to sell the investment in a short period of time without significant price concessions? A.Interest-rate risk. B.Financial risk. C.Purchasing-power risk. D.Liquidity risk.

D.Liquidity risk.Answer (D) is correct. Liquidity risk is the possibility that an asset cannot be sold on short notice for its market value. If an asset must be sold at a high discount, it is said to have a substantial amount of liquidity risk.

Stock J has a beta of 1.2 and an expected return of 15.6%, and stock K has a beta of 0.8 and an expected return of 12.4%. What is the market return and the risk-free rate, consistent with the capital asset pricing model? A.Market return is 12.4%; risk-free rate is 0%. B.Market return is 14%; risk-free rate is 1.6%. C.Market return is 14%; risk-free rate is 4%. D.Market return is 14%; risk-free rate is 6%.

D.Market return is 14%; risk-free rate is 6%.Answer (D) is correct. This problem requires the use of simultaneous equations. Set up a CAPM formula for each stock:Stock J: 15.6%=RF + 1.2 (RM - RF)Stock K: 12.4%=RF + .8 (RM - RF) Remove the parentheses and combine terms:Stock J: 15.6%=1.2RM - .2RFStock K: 12.4%=.8RM + .2RF Then add the two equations above to solve for RM:15.6% + 12.4%=1.2RM - .2RF +.8RM +.2RF28%=2RMRM=14% Substitute 14% for RM in the second equation:12.4%=RF + .8(14% - RF)12.4%=.2 RF + 11.2%1.2%=.2 RF, or RF = 6%

Management utilizes all of the following procedures to develop accounting estimates except A.Predicting most likely circumstances and scenarios. B.Presenting estimates in conformity with GAAP. C.Understanding factors affecting the study. D.Minimizing disclosure of underlying assumptions.

D.Minimizing disclosure of underlying assumptions.Answer (D) is correct. Management is obligated to disclose underlying assumptions that are the basis for accounting estimates.

The difference between the required rate of return on a given risky investment and that on a riskless investment with the same expected return is the A.Coefficient of variation. B.Beta coefficient. C.Standard deviation. D.Risk premium.

D.Risk premium.Answer (D) is correct. The required rate of return on equity capital in the capital asset pricing model is the risk-free rate (determined by government securities) plus the product of the market risk premium times the beta coefficient (beta measures the firm's risk). The market risk premium is the amount above the risk-free rate that will induce investment in the market. The beta coefficient of an individual stock is the correlation between the volatility (price variation) of the stock market and that of the price of the individual stock.

A market analyst has estimated the equity beta of Modern Homes, Inc., to be 1.4. This beta implies that the company's A.Unsystematic risk is higher than that of the market portfolio. B.Systematic risk is lower than that of the market portfolio. C.Total risk is higher than that of the market portfolio. D.Systematic risk is higher than that of the market portfolio.

D.Systematic risk is higher than that of the market portfolio.Answer (D) is correct. Systematic risk, also called market risk or undiversifiable risk, is the risk of the stock market as a whole. Some conditions in the national economy affect all businesses, which is why equity prices so often move together. The effect of an individual security on the volatility of a portfolio is measured by its sensitivity to movements by the overall market. This sensitivity is stated in terms of a stock's beta coefficient. An average-risk stock has a beta of 1.0 because its returns are perfectly positively correlated with those on the market portfolio.

What does Beta measure in the capital asset pricing model? A.The volatility of a stock relative to its competitors. B.Unsystematic risk. C.The additional return required over the risk-free rate. D.The volatility of a stock relative to the market.

D.The volatility of a stock relative to the market.Answer (D) is correct. Beta (β) measures the volatility of an individual security's returns relative to the equity returns of the overall market. It is also called market risk.

To determine the best cost driver of warranty costs relating to glass breakage during shipments, Wymer Co. used simple linear regression analysis to study the relationship between warranty costs and each of the following variables: type of packaging, quantity shipped, type of carrier, and distance shipped. The analysis yielded the following statistics:IndependentCoefficient ofStandard ErrorVariableDeterminationof RegressionType of packaging0.601,524Quantity shipped0.481,875Type of carrier0.452,149Distance shipped0.204,876 Based on these analyses, the best driver of warranty costs for glass breakage is A.Type of carrier. B.Distance shipped. C.Quantity shipped. D.Type of packaging.

D.Type of packaging.Answer (D) is correct. The best cost driver (independent variable) is the one that is most closely related to the incurrence of the cost. This is indicated by a high coefficient of determination (the proportion of the total variation of the dependent variable, or warranty costs, explained by the regression equation) and a low standard error of regression (the tightness of fit between the raw data and the regression equation). For glass breakage, the type of packaging is the best cost driver because it has both the highest coefficient of determination and the lowest standard error of regression.

Sago Co. uses regression analysis to develop a model for predicting overhead costs. Two different cost drivers (machine hours and direct materials weight) are under consideration as the independent variable. Relevant data were run on a computer using one of the standard regression programs, with the following results:Machine hoursCoefficienty intercept2,500b5.0r² = .70Direct materials weighty intercept4,600b2.6r² = .50 Which regression equation should be used? A.y = 4,600 + 1.3x B.y = 2,500 + 3.5x C.y = 4,600 + 2.6x D.y = 2,500 + 5.0x

D.y = 2,500 + 5.0xAnswer (D) is correct. The simple regression equation is y = a + bx, given that y is the dependent variable, a is the y-axis intercept, b is the slope of the regression line, and x is the independent variable. The coefficient of determination (r²) is the appropriate tool for determining which cost driver to use because the value of r² indicates the proportion of the total variation in y that is explained by the regression equation. Since machine hours has a higher r² than direct materials weight, the coefficients for machine hours are the better choice to predict costs. Consequently, the regression equation is y = 2,500 + 5.0x.

n preparing the annual profit plan for the coming year, Wilkens Company wants to determine the cost behavior pattern of the maintenance costs. Wilkens has decided to use linear regression by employing the equation y = a + bx for maintenance costs. The prior year's data regarding maintenance hours and costs, and the results of the regression analysis, are given below and in the opposite column.Average cost per hour$9.00a684.65b7.2884Standard error of a49.515Standard error of b.12126Standard error of the estimate34.469r2.99724 Hours of Activity Maintenance Costs January 480 $ 4,200 February 320 3,000 March 400 3,600 April 300 2,820 May 500 4,350 June 310 2,960 July 320 3,030 August 520 4,470 September 490 4,260 October 470 4,050 November 350 3,300 December 340 3,160 Sum 4,800 $43,200 Average 400 $ 3,600 If Wilkens Company uses the high-low method of analysis, the equation for the relationship between hours of activity and maintenance cost would be A.y = 400 + 9.0x B.y = 3,600 + 400x C.y = 570 + 9.0x D.y = 570 + 7.5x

D.y = 570 + 7.5xAnswer (D) is correct. First, determine the months with the highest (520 hours in August) and lowest (300 hours in April) levels of activity.HoursDollarsAugust520$ 4,470April3002,820Difference220$ 1,650 As the hours increased by 220, cost increased by $1,650, which is $7.50 ($1,650 ÷ 220) per hour. Thus, at 300 hours of activity, the total variable costs are $2,250 ($7.50 × 300 hours). Since the total cost was $2,820, the $570 ($2,820 - $2,250) above the variable costs must be fixed costs. Substituting into the standard regression equation of y = a + bx gives y = $570 + $7.50x.