Big Time 1.8

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"The Seattle Corporation has been presented with an investment opportunity which will yield end of year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year10. This investment will cost the firm $150,000 today, and the firm's required rate of return is 10 percent. What is the NPV for this investment?"

CF0 = -150000 CF1-CF4 = 30000 CF5-CF9= 35000 CF10= 40000 I=10 CPT OF NPV ANSWER = 51, 138.24

Choose the correct answer for the following: (1) Which is the best measure of risk for choosing an asset which is to be held in isolation? (2) Which is the best measure for choosing an asset to be held as part of a diversified portfolio?

Coefficient of variation; beta

You observe the following information regarding Companies X and Y: • Company X has a higher expected return than Company Y. • Company X has a lower standard deviation of returns than Company Y. • Company X has a higher beta than Company Y. Given this information, which of the following statements is CORRECT?

Company X has a lower coefficient of variation than Company Y.

True

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

True

Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

Which of the following statements is CORRECT? a. Because of their size, large corporations face fewer regulations than smaller corporations and proprietorships. b. Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders. c. Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders' interests. d. Corporations have unlimited liability. e. Corporations are taxed more favorably than proprietorships.

Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders.

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

C! Bondholders prefer steady consistent promised long-term investment decisions.

"You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and10. If you require a 12 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?"

C01 = 5000 F01 = 5 C02 = 3000 F02 = 3 C03 = 2000 F03 = 2 I = 12 CPT NPV ANSWER : 23,477.63

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE? a. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta. b. The beta of an "average stock," or "the market," can change over time, sometimes drastically. c. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. d. All of the statements above are true. e. The fact that a security or project may not have a past history that can be used as the basis for calculating beta.

b. The beta of an "average stock," or "the market," can change over time, sometimes drastically.

In a portfolio of three randomly selected stocks, which of the following could NOT be true; i.e., which statement is false? a. The standard deviation of the portfolio is greater than the standard deviation of one or two of the stocks. b. The beta of the portfolio is lower than the lowest of the three betas. c. The beta of the portfolio is equal to one of the three stock's betas. d. The beta of the portfolio is equal to 1. e. The standard deviation of the portfolio is less than the standard deviation of each of the stocks if they were held in isolation.

b. The beta of the portfolio is lower than the lowest of the three betas.

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

b. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter? a. Stock A. b. Stock B. c. Neither A nor B, as neither has a return sufficient to compensate for risk. d. Add A, since its beta must be lower. e. Either A or B, i.e., the investor should be indifferent between the two.

b. Stock B.

Suppose that during the coming year, the risk free rate, rRF, is expected to remain the same, while the market risk premium (rM − rRF), is expected to fall. Given this forecast, which of the following statements is CORRECT? a. The required return on all stocks will remain unchanged. b. The required return will fall for all stocks, but it will fall more for stocks with higher betas. c. The required return for all stocks will fall by the same amount. d. The required return will fall for all stocks, but it will fall less for stocks with higher betas. e. The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.

b. The required return will fall for all stocks, but it will fall more for stocks with higher betas.

Which of the following statements is CORRECT? a. The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. b. Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future. c. If investors become less risk averse, the slope of the Security Market Line will increase. d. If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock. e. The slope of the SML is determined by the value of beta.

b. Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future.

Which of the following statements is CORRECT? a. If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. b. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. c. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. d. It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF. e. The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.

b. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.

Which of the following statements is CORRECT? a. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. b. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. c. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. d. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate. e. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

b. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.

Portfolio AB was created by investing in a combination of Stocks A and B. Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT? a. Stock A has more market risk than Stock B but less stand-alone risk. b. Portfolio AB has more money invested in Stock A than in Stock B. c. Portfolio AB has the same amount of money invested in each of the two stocks. d. Portfolio AB has more money invested in Stock B than in Stock A. e. Stock A has more market risk than Portfolio AB.

b. Portfolio AB has more money invested in Stock A than in Stock B.

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P has 50% invested in Stock A and 50% invested in B. Which of the following statements is CORRECT? a. Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. b. Portfolio P has more market risk than Stock A but less market risk than B. c. Stock A should have a higher expected return than Stock B as viewed by the marginal investor. d. Portfolio P has a coefficient of variation equal to 2.5. e. Portfolio P has a standard deviation of 25% and a beta of 1.0.

b. Portfolio P has more market risk than Stock A but less market risk than B.

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

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

The two stocks in your portfolio, X and Y, have independent returns, so the correlation between them, rXY is zero. Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. Which of the following statements best describes the characteristics of your 2-stock portfolio? a. Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. b. Your portfolio has a beta equal to 1.6, and its expected return is 15%. c. Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. d. Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6. e. Your portfolio has a standard deviation of 30%, and its expected return is 15%.

b. Your portfolio has a beta equal to 1.6, and its expected return is 15%.

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

b. among the factors that are responsible for market risk.

(Quiz/Sub#1)A bond that is payable to whomever has physical possession of the bond is said to be in: registered form collateral status debenture status new-issue condition bearer form

bearer form Feedback: Bearer status is the answer. This is mostly a bad plot device in movies, as no bearer bonds have been issued in decades, http://www.ppm.net/services/144a-offering/bearer-bonds/bearer-bonds-from-popular-to-prohibited/

Assume that you are the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect (and require) on this fund? Stock Amount Beta A $1,075,000 1.20 B 675,000 0.50 C 750,000 1.40 D 500,000 0.75 $3,000,000

c. 11.11%

Zacher Co.'s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return? a. 11.36% b. 11.65% c. 11.95% d. 12.25% e. 12.55%

c. 11.95%

CCC Corp has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would CCC's new required return be?

c. 16.50%

Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

c. 9.21%

Freedman Flowers' stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a −28% return. What is the firm's expected rate of return? a. 9.41% b. 9.65% c. 9.90% d. 10.15% e. 10.40%

c. 9.90%

Taggart Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

c. 9.90%

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT? a. Stock Y must have a higher expected return and a higher standard deviation than Stock X. b. If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. c. If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. d. If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. e. A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.

c. If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.

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

c. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.

(Quiz/Sub#2)A $1,000 face value bond can be redeemed early at the issuer's discretion for $1,030, plus any accrued interest. The additional $30 is called which one of the following? redemption value original-issue discount redemption discount call premium dirty price

call premium

Kollo Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return?

d. 10.17%

Calculate the required rate of return for Climax Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.

d. 12.00%

Calculate the required rate of return for Everest Expeditions Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years. a. 10.29% b. 10.83% c. 11.40% d. 12.00% e. 12.60%

d. 12.00%

Assume that your uncle holds just one stock, East Coast Bank (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for West Coast Bank (WCB). Both banks have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would your uncle's risk have been reduced if he had held a portfolio consisting of 60% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.) Year ECB WCB 2008 40.00% 40.00% 2009 -10.00% 15.00% 2010 35.00% -5.00% 2011 -5.00% -10.00% 2012 15.00% 35.00% Average return = 15.00% 15.00% Standard deviation = 22.64% 22.64%

d. 3.84%

. Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return. What is the firm's expected rate of return? a. 7.72% b. 8.12% c. 8.55% d. 9.00% e. 9.50%

d. 9.00%

Dothan Inc.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return?

d. 9.00%

Which of the following statements is CORRECT? a. If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. b. The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return. c. Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio. d. A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock. e. A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.

d. A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%. Which of the following statements is CORRECT? a. If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0. b. Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's. c. If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. d. If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0. e. If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta.

c. If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.

Gretta's portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. The risk-free rate is 6% and the market risk premium is 5%. Which of the following statements is CORRECT? a. The required return on the market is 10%. b. The portfolio's required return is less than 11%. c. If the risk-free rate remains unchanged but the market risk premium increases by 2%, Gretta's portfolio's required return will increase by more than 2%. d. If the market risk premium remains unchanged but expected inflation increases by 2%, Gretta's portfolio's required return will increase by more than 2%. e. If the stock market is efficient, Gretta's portfolio's expected return should equal the expected return on the market, which is 11%.

c. If the risk-free rate remains unchanged but the market risk premium increases by 2%, Gretta's portfolio's required return will increase by more than 2%.

Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. Expected Standard Stock Return Deviation Beta A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT? a. Portfolio AB's coefficient of variation is greater than 2.0. b. Portfolio AB's required return is greater than the required return on Stock A. c. Portfolio ABC's expected return is 10.66667%. d. Portfolio ABC has a standard deviation of 20%. e. Portfolio AB has a standard deviation of 20%.

c. Portfolio ABC's expected return is 10.66667%.

Stocks A and B are quite similar: Each has an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT? a. Portfolio P has a standard deviation that is greater than 25%. b. Portfolio P has an expected return that is less than 12%. c. Portfolio P has a standard deviation that is less than 25%. d. Portfolio P has a beta that is less than 1.2. e. Portfolio P has a beta that is greater than 1.2.

c. Portfolio P has a standard deviation that is less than 25%.

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT? a. Portfolio P's expected return is equal to the expected return on Stock A. b. Portfolio P's expected return is less than the expected return on Stock B. c. Portfolio P's expected return is equal to the expected return on Stock B. d. Portfolio P's expected return is greater than the expected return on Stock C. e. Portfolio P's expected return is greater than the expected return on Stock B.

c. Portfolio P's expected return is equal to the expected return on Stock B.

Which of the following statements is CORRECT? a. Portfolio diversification reduces the variability of returns on an individual stock. b. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events. c. The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. d. A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio. e. When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

c. The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.

Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks? a. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. b. The beta of the portfolio is less than the average of the betas of the individual stocks. c. The beta of the portfolio is equal to the average of the betas of the individual stocks. d. The beta of the portfolio is larger than the average of the betas of the individual stocks. e. The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.

c. The beta of the portfolio is equal to the average of the betas of the individual stocks.

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels, a. The past realized rate of return must be equal to the expected future rate of return; that is, . b. The required rate of return must equal the past realized rate of return; that is, r = . c. The expected rate of return must be equal to the required rate of return; that is, = r. d. All of the above statements must hold for equilibrium to exist; that is = r = . e. None of the above statements is correct.

c. The expected rate of return must be equal to the required rate of return; that is, = r.

Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securities? (Assume market equilibrium.) a. Stock B must be a more desirable addition to a portfolio than A. b. Stock A must be a more desirable addition to a portfolio than B. c. The expected return on Stock A should be greater than that on B. d. The expected return on Stock B should be greater than that on A. e. When held in isolation, Stock A has more risk than Stock B.

c. The expected return on Stock A should be greater than that on B.

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines, with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT? a. The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. b. Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. c. The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. d. The required return of all stocks will fall by the amount of the decline in the market risk premium. e. The required return of all stocks will increase by the amount of the increase in the risk-free rate.

c. The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.

(Quiz/Sub#5)Cornwall Corporation is planning to raise $1,000,000 to finance a new plant. Which of the following statements is CORRECT? If debt is used to raise the million dollars, but $500,000 is raised as first mortgage bonds on the new plant and $500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds. If two tiers of debt are used (with one senior and one subordinated debt class), the subordinated debt will carry a lower interest rate. If debt is used to raise the million dollars, the cost of the debt would be lower if the debt were in the form of a fixed-rate bond rather than a floating-rate bond. If debt is used to raise the million dollars, the cost of the debt would be higher if the debt were in the form of a mortgage bond rather than an unsecured term loan.

If debt is used to raise the million dollars, but $500,000 is raised as first mortgage bonds on the new plant and $500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds. Feedback: Since the mortgage bonds are backed by collateral they are less risky than debentures so investors would take a lower interest rate.

Which of the following statements is CORRECT??

If expected inflation increases, interest rates are likely to increase.

True

If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the lower standard deviation

False

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase

(Quiz/Sub#5)A 15-year bond has an annual coupon rate of 8%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 6%. Which of the following statements is CORRECT? The bond is currently selling at a price below its par value. If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today. The bond should currently be selling at its par value. If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today.

If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today. Feedback: The bond is currently selling at a premium. After a year the price of the bond will decrease because as the bond nears maturity the price converges to par value.

Which of the following statements is CORRECT?

If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

If the EXPECTED RATE of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

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

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.

True

If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation, the risk-free rate will also increase. If there is no change in investors' risk aversion, then the market risk premium (rM - rRF) will remain constant. Also, if there is no change in stocks' betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.

True

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%. Which of the following statements is CORRECT?

If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%.

Which of the following statements is CORRECT?

If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

Which of the following statements is CORRECT?

If you FORMED A PORTFOLIO that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.

True

If you plotted the returns of a company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a welldiversified investor, assuming that the observed relationship is expected to continue in the future.

(Quiz/Sub#3)A bond matures in 12 years, and pays an 8 percent annual coupon. The bond has a face value of $1,000, and currently sells for $985. What is the bond's current yield and yield to maturity? Current yield = 8.00%; yield to maturity = 7.92%. Current yield = 8.12%; yield to maturity = 8.20%. Current yield = 8.20%; yield to maturity = 8.37%. Current yield = 8.12%; yield to maturity = 8.37%. Current yield = 8.12%; yield to maturity = 7.92%.

Current yield = 8.12%; yield to maturity = 8.20% Feedback: N = 12PV = -985PMT = 80FV = 1,000Solve for I/YR (YTM) = 8.20%.Current yield is calculated as:$80/$985 = 8.12%.

False

If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the riskfree rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

Jessie's Bobcat Rentals' operations provided a negative net cash flow last year, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company's financial statements were prepared under generally accepted accounting principles? a. The company retired a large amount of its long-term debt. b. The company repurchased some of its common stock. c. The company had high depreciation expenses. d. The company sold some of its fixed assets. e. The company dramatically increased its capital expenditures.

A major disadvantage of the payback period method is it__________________________________________________________.

Ignores cash flows beyond the payback period

Which of the following would be most likely to occur in the year after Congress, in an effort to increase tax revenue, passed legislation that forced companies to depreciate equipment over longer lives? Assume that sales, other operating costs, and tax rates are not affected, and assume that the same depreciation method is used for tax and stockholder reporting purposes. a. Companies' physical stocks of fixed assets would increase. b. Companies' reported net incomes would decline. c. Companies' net operating profits after taxes (NOPAT) would decline. d. Companies' net cash flows would increase. e. Companies' cash positions would decline

D! Lower depreciation write-offs mean higher taxes and thus lower cash flow.

Which of the following statements is CORRECT?

DIVERSIFIABLE RISK can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.

Which of the following statements is CORRECT?

DURING a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

3. Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift

Down and have steeper slope.

Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance? a. The company's operating income declined. b. The company's expenditures on fixed assets declined. c. The company's interest expense increased. d. The company's cost of goods sold increased. e. The company's depreciation and amortization expenses declined.

Which of the following statements is CORRECT? a. A good goal for a firm's management is the maximization of expected EPS. b. Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. c. Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited. d. Because most stock ownership is concentrated in the hands of a relatively small segment of society, firms' actions to maximize their stock prices have little benefit to society. e. The potential exists for agency conflicts between stockholders and managers.

Which of the following statements is CORRECT? a. Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value than are managers who do not face the threat of hostile takeovers. b. Corporations generally are subject to more favorable tax treatment and fewer regulations than partnerships and sole proprietorships, which is why corporations do most of the business in the United States. c. Because of their simplified organization, it is easier for sole proprietorships and partnerships to raise large amounts of outside capital than it is for corporations. d. Bond covenants are an effective way to resolve conflicts between shareholders and managers. e. One advantage of the corporate form of organization is that liability of the owners of the firm is limited to their investment in the firm.

Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year, even though the cash on its balance sheet increased? a. The company paid a large dividend. b. The company repurchased 20% of its common stock. c. The company had high amortization expenses. d. The company made a large investment in new plant and equipment. e. The company sold a new issue of bonds.

E! Since when the company issues bonds it increases the cash inflow in the first year and in the future year in financing activities it reports cash paid every year as interest on bonds. So that's how it had a negative cash flow.

On its 2014 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount was shown the following year in 2015. Assuming that no earnings restatements were issued, which of the following statements is CORRECT? a. If the company lost money in 2015, they must have paid dividends. b. The company must have paid out half of its earnings as dividends. c. The company must have paid no dividends in 2015. d. The company must have had zero net income in 2015. e. Dividends could have been paid in 2015, but they would have had to equal the earnings for the year.

E! We know that there is no change in the retained earnings which means the company paid all its earnings in 2015 as dividends so there was no net income retained in 2015.

False

Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.

A portfolio will always have a lower standard deviation than the standard deviation of any of the component securities.

FALSE

Every firm has an optimal capital structure, which is defined as the mix of debt, preferred stock, and common equity that minimizes its component cost of equity

FALSE

If Ford Motor Company has a correlation coefficient of .82 with General Motors Corporation, then every 1% change in Ford's returns causes a .82% change in the General Motors return.

FALSE

It is impossible for a security' beta to be equal to zero if its standard deviation is positive

FALSE

It is possible for a firm to have an overstated weighted average cost of capital (WACC) if there are idle assets on the balance sheet

FALSE

The cost of retained earnings is higher than the cost of new common equity due to flotation costs

FALSE

The difference between correlation and covariance is that covariance is a standardized measure and correlation is a measure of total movement

FALSE

The expected return on an investment is the standard deviation of its probability distribution of possible returns

FALSE

The minimum rate of return on an investment is the standard deviation of its probability distribution of possible returns

FALSE

Using CAPM (rs=rf+(rm-rf)B will always generate the appropriate estimate of the cost of equity in the weighted average cost of capital (WACC) calculation

FALSE

When a company has more than one issue of debt outstanding, the weighted average cost of capital calculation (WACC) correctly adjusts for the price risk on bonds by using the market yeild

FALSE

If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses.

False

If management operates in a manner designed to maximize the firm's expected profits for the current year, this will also maximize the stockholders' wealth as of the current year.

False

In order to maximize its shareholders' value, a firm's management must attempt to maximize the expected EPS.

False

In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price on a specific target date.

False

Partnerships and proprietorships generally have a tax advantage over corporations.

False

(Quiz/Sub#3)A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond. True False

False Feedback: The callable bond will be called if rates fall far enough below the coupon rate, but it will not be called otherwise. Thus, the call provision can only harm bondholders. Therefore, callable bonds sell at higher yields than noncallable bonds, regardless of the slope of the yield curve.

Gilligan Co.'s bonds currently sell for $1,150. They have a 6.75% annual coupon rate and a 15-year maturity, and are callable in 6 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds, the YTC or the YTM? a. 4.34% b. 4.81% c. 3.92% d. 4.57% e. 4.12%

(Quiz/Sub#1)A bond has a market price that exceeds its face value. Which of the following features currently apply to this bond? I. discounted price II. premium price III. yield-to-maturity that exceeds the coupon rate IV. yield-to-maturity that is less than the coupon rate II and IV only I and III only III only I and IV only II and III onl

II and IV only Feedback: Above face/$1000 means premium. Prices rise when rates fall, thus yield to maturity is less than the coupon rate. THIS IS A VERY IMPORTANT CONCEPT IN FINANCE.

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?

If Stock A's required return is 11%, then the market risk premium is 5%.

Which of the following statements is most correct?l

If a coupon bond is selling at par, its current yield equals its yield to maturity.

Which of the following statements is most correct?o

If a coupon bond is selling at par, its current yield equals its yield to maturity.

7. Which of the following statements is most correct?r

If a market is strong-form efficient this implies that the returns on bonds and stocks should be identical. b. If a market is weak-form efficient this implies that all public information is rapidly incorporated into market prices. c. If your uncle earns a return higher than the overall stock market, this means the stock market is inefficient. d. None of the above answers is correct.

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

If a stock has a negative beta, its required return under the CAPM would be less than 5%.

Which of the following statements is CORRECT?

If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.

False

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.

Which of the following statements is CORRECT????

Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership.

True

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

False

Portfolio A has only one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB was created by investing in a combination of Stocks A and B. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?

Portfolio AB has more money invested in Stock A than in Stock B.

Portfolio AB's expected return is 11.0%

Portfolio ABC's expected return is 10.66667%.

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?

Portfolio P has a STANDARD DEVIATION that is less than 25%.

Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

Portfolio P has a beta of 1.0

Portfolio P has more market risk than Stock A but less market risk than B.

Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?

Portfolio P has the same required return as the market (rM).

Portfolio P's expected return is equal to the expected return on Stock B.

Which of the following statements is CORRECT?

Potential agency problems can arise between managers and stockholders, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders.

"Oakdale Furniture Inc. has a beta coefficient of 0.7 and a required rate of return of 15 percent. The market risk premium is currently 5 percent. If the inflation premium increases by 2 percentage points, and Oakdale acquires new assets which increase its beta by 50 percent, what will be Oakdale's new required rate of return?"

Required return= Risk Free Rate of Return + Beta(Risk Premium) ks (Required Rate of Return) = 15% = kRF + (5%)0.7; Rsik free Rate of Return = kRF = 15% - 3.5%; So kRF = 11.5%. New kRF = 11.5% + 2.0% = 13.5%. New beta = 0.7 * 1.5 = 1.05. New required rate of return: ks = 13.5% + (5%)1.05 = 18.75% ANSWER: 18.75%

Rogoff Co.'s 15-year bonds have an annual coupon rate of 9.5%. Each bond has face value of $1,000 and makes semiannual interest payments. If you require an 11.0% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? a. $936.10 b. $983.49 c. $959.51 d. $891.00 e. $913.27

Listed below are some provisions that are often contained in bond indentures. Which of these provisions, viewed alone, would tend to reduce the yield to maturity that investors would otherwise require on a newly issued bond? 1. Fixed assets are used as security for a bond. 2. A given bond is subordinated to other classes of debt. 3. The bond can be converted into the firm's common stock. 4. The bond has a sinking fund. 5. The bond has a call provision. 6. The indenture contains covenants that prevent the use of additional debt. a. 1, 3, 4, 5, 6 b. 1, 3, 4, 6 c. 1, 2, 3, 4, 6 d. 1, 2, 3, 4, 5, 6 e. 1, 4, 6

Which of the following statements is most correct?'

Market participants are able to eliminate virtually all company- specific risk if they hold a large diversified portfolio of stocks.

True

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to

Maximize the stock price per share over the long run, which is the stock's intrinsic value.

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to

Maximize the stock price per share over the long run, which is the stock's intrinsic value

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to...

Maximize the stock price per share over the long run, which is the stock's intrinsic value

True

Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets. The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders.

(EOCP-5-3)Heath Food Corporation's bonds have 7 years remaining to maturity. The bonds have a face value of $1,000 and a yield to maturity of 8%. They pay interest annually and have a 9% coupon rate. What is their current yield?

N = 7; I/YR = YTM = 8; PMT = 0.09 1,000 = 90; FV = 1000; PV = VB = ? PV = $1,052.06. Current yield = $90/$1,052.06 = 8.55%. Alternatively, VB = $90((1- 1/1.087)/0.08) + $1,000(1/1.087) = $1,052.06 Current yield = $90/$1,052.06 = 8.55%

Benefits of the post-audit include all of the following except

Negative NPV projects are identified before they begin

Which of the following statements is CORRECT? a. Corporations face few regulations and more favorable tax treatment than do proprietorships and partnerships. b. Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers. c. Bond covenants are an effective way to resolve conflicts between shareholders and managers. d. Because of their simplified organization, it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations. e. One advantage to forming a corporation is that the owners of the firm have limited liability.

One advantage to forming a corporation is that the owners of the firm have limited liability.

True

One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM.

Which of the following statements is CORRECT? a. One of the advantages of the corporate form of organization is that it avoids double taxation. b. It is easier to transfer one's ownership interest in a partnership than in a corporation. c. Corporations of all types are subject to the corporate income tax. d. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability. e. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote."

One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability.

One year ago Lerner and Luckmann Co. issued 15-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 14 years to maturity? a. $1,104.62 b. $1,191.79 c. $1,132.95 d. $1,162.00 e. $1,077.01

Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed's actions would lead to a recession, and that led to an increase in the market risk premium, (rM - rRF). Under these conditions, with other things held constant, which of the following statements is most correct?

The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.

(EOCP-5-7)Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity of 8.5%. What is the price of the bonds?

The problem asks you to find the price of a bond, given the following facts: N = 16; I/YR = 8.5/2 = 4.25; PMT = 50; FV = 1000. With a financial calculator, solve for PV = $1,085.80

"When Richard evaluated a capital budgeting project a new machine needed to manufacture inventory using his firm's required rate of return, he discovered that the project's net present value (NPV) is negative. Based on this information, which of the following must be correct?"

The project's discounted payback period is greater than its economic life

Over the past 84 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?

Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

True

Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities. Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.

Sommers Co.'s bonds currently sell for $1,080 and have a par value of $1,000. They pay a $100 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,125. What is their yield to maturity (YTM)? a. 9.46% b. 10.43% c. 9.93% d. 9.01% e. 8.56%

"__________ is a measure of total risk, whereas __________ is a measure of systematic risk"

Standard deviation; beta

Which of the following statements is most correct? w

The constant growth model takes into consideration the capital gains earned on a stock

False

The distributions of rates of return for Companies AA and BB are given below: State of the Economy Probability of This State Occurring AA BB Boom 0.2 30% -10% Normal 0.6 10% 5% Recession 0.2 -5% 50% We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?

The diversifiable risk of your portfolio will likely decline, but the expected market risk should NOT CHANGE.

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

The expected rate of return must be equal to the required rate of return; that is, = r.

Stephenson Co.'s 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? a. The bond's yield to maturity is greater than its coupon rate. b. The bond's current yield is equal to its coupon rate. c. The bond's current yield exceeds its yield to maturity. d. If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850. e. The bond's coupon rate exceeds its current yield.

Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM − rRF, is 6%. Assume that the market is in equilibrium. Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is CORRECT?

Stock A's beta is 0.8333

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

Stock B

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

TRUE

It is possible for two assets to appear to be correlated when, in fact, there is no relationship at all between them

TRUE

Standard deviation is a measure of total (stand-alone) risk which includes business risk, industry risk and beta (market) risk.

TRUE

The elements comprising diversifiable business and industry risk generally explain more than 50% of the total risk of most securities' annual returns

TRUE

The one type of risk that can never be diversified away is market risk

TRUE

The standard deviation of a leveraged portfolio will always be a linear combination of the percentage of debt taken on.

TRUE

The weighted average cost of capital calculation (WACC) as outlined in the text book is always wrong and sometimes it matters

TRUE

Which of the following statements is CORRECT?

The BETA COEFFICIANT of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the FUTURE.

False

The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.

Which of the following statements is CORRECT?

The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.

Which of the following statements is most correct?

The SML relates required returns to firms' market risk. The slope and intercept of this line cannot be controlled by the financial manager.

False

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions

False

The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.

True

The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

The beta of an "average stock," or "the market," can change over time, sometimes DRASTICALLY

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

The beta of the portfolio is EQUALl to the weighted average of the betas of the individual stocks.

"In a portfolio of three different stocks, which of the following could not be true?"

The beta of the portfolio is less than the beta of each of the individual stocks.

In a portfolio of three different stocks, which of the following could not be true?

The beta of the portfolio is less than the beta of each of the individual stocks.

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)

The expected return on Stock A will be greater than that on Stock B

Which of the following statements is most correct?u

The expected return on a corporate bond is always less than its promised return when the probability of default is greater than zero. b. All else equal, secured debt is considered to be less risky than unsecured debt. Both a and b are correct.

Which of the following is not a function of the value of a firm?

The number of divisions.

You just purchased a 10-year corporate bond that has an annual coupon of 10 percent. The bond sells at a premium above par. Which of the following statements is most correct?

The bond's yield to maturity is less than 10 percent.

(Quiz/Sub#4)Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT? The prices of both bonds will remain unchanged. The price of Bond A will decrease over time, but the price of Bond B will increase over time. The prices of both bonds will increase by 7% per year. The prices of both bonds will increase over time, but the price of Bond A will increase by more.

The price of Bond A will decrease over time, but the price of Bond B will increase over time. Feedback: Bond A is currently selling at a premium while bond B is selling at a discount. As time goes by the prices of the bonds will converge to par value in order to maintain the YTM.

The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

(Quiz/Sub#3)Ranger Inc. would like to issue new 20-year bonds. Initially, the plan was to make the bonds non-callable. If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return? There is no reason to expect a change in the required rate of return. The required rate of return would decline because the bond would then be less risky to a bondholder. The required rate of return would increase because the bond would then be more risky to a bondholder. It is impossible to say without more information.

The required rate of return would increase because the bond would then be more risky to a bondholder.

The required return on Portfolio P would increase by 1%.

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?

The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?

The required return on a stock with a positive beta < 1.0 will decline

During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

The required return will fall for all stocks, but it will fall more for stocks with higher betas.

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0

The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.

The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.

False

The slope of the SML is determined by the value of beta.

Which of the following statements is CORRECT?

The slope of the security market line is equal to the market risk premium, (rM − rRF).

Which of the following statements is CORRECT?

The slope of the security market line is equal to the market risk premium.

Which of the following statements is correct?"

The slope of the security market line is measured by beta.

Which of the following statements is incorrect?

The slope of the security market line is measured by beta.

False

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly

If the expected rate of return on a stock exceeds the required rate,

The stock is a good buy.

Which of the following statements is most correct.

The stock valuation model, P0 = D1/(rs - g), can be used for firms which have negative growth rates

A stock's dividend is expected to grow at a constant rate of 5 percent a year. Which of the following statements is most correct?

The stock's price one year from now is expected to be 5 percent higher.

False

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

The y-axis intercept would decline, and the slope would increase

"You are an investor in common stock, and you currently hold a well-diversified portfolio which has an expected return of 12 percent, a beta of 1.2, and a total value of $9,000. You plan to increase your portfolio by buying 100 shares of AT&E at $10 a share. AT&E has an expected return of 20 percent with a beta of 2.0. What will be the expected return and the beta of your portfolio after you purchase the new stock?"

Total value after purchase=9000+(100*10)=$10,000 Hence expected return of portfolio=Respective returns*Respective weights =(0.12*9000/10,000)+(0.2*1000/10000) =12.8% Expected beta=Respective beta*Respective weights =(1.2*9000/10000)+(2*1000/10000) =1.28. ANSWER: 12.8 % AND 1.28

(Quiz/Sub#2)If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk True False

True

If a corporation elects to be taxed as an S corporation, then it can avoid the corporate tax. However, its stockholders will have to pay personal taxes on the firm's net income.

True

Organizing as a corporation makes it easier for the firm to raise capital. This is because corporations' stockholders are not subject to personal liabilities if the firm goes bankrupt and also because it is easier to transfer shares of stock than partnership interests.

True

The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.

True

The more capital a firm is likely to require, the greater the probability that it will be organized as a corporation.

True

(Quiz/Sub#3)For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures. True False

True Feedback: Interest rate risk reflects the lenth of time one is commited to a given investment Feedback: Since zero coupon bonds do not pay coupon payments and only pay out at maturity they are more at risk to interest rates. Remember the longer the time to maturity the greater the exposure to interest rate risk.

(Quiz/Sub#4)Other things equal, a firm will have to pay a higher coupon rate on a subordinated debenture than on a second mortgage bond. True False

True Feedback: Subordinated Debentures are unsecured bonds and second mortgage bonds are secured bonds. Because Subordinated Debentures are unsecured, therefore riskier, investments, they have a higher rate of return.

Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par? a. Adding a call provision. b. The rating agencies change the bond's rating from Baa to Aaa. c. Adding a sinking fund. d. Adding additional restrictive covenants that limit management's actions. e. Making the bond a first mortgage bond rather than a debenture.

False

Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return

True

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, the standard deviation

The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to

WRONG - Maximize the fir's expected EPS, which must also maximize the firm's price per share.

Which of the following statements is CORRECT?

WRONG - Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships.

False

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

False

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio

True

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

Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds? a. Inflation increases significantly. b. Market interest rates rise sharply. c. The company's financial situation deteriorates significantly. d. The company's bonds are downgraded. e. Market interest rates decline sharply.

Exposure to taxation of corporate earnings and stockholder dividend income.

Which of the following represents a significant disadvantage to the corporate form of organization?

Which of the following statements is CORRECT? a. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value. b. Other things held constant, a corporation would rather issue noncallable bonds than callable bonds. c. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value. d. Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon. e. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.

Which of the following statements is CORRECT? a. Most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature. b. Sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time. c. If interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price. d. Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued. e. A sinking fund provision makes a bond more risky to investors at the time of issuance.

(EOCP-5-8)Thatcher Corporation's bonds will mature in 10 years. The bonds have a face value of $1,000 and an 8% coupon rate, paid semiannually. The price of the bonds is $1,100. The bonds are callable in 5 years at a call price of $1,050. What is their yield to maturity? What is their yield to call?

With your financial calculator, enter the following to find YTM: N=102=20; PV=-1100; PMT=0.08/21,000=40; FV=1000; I/YR =YTM=? YTM = 3.31% 2 = 6.62%. With your financial calculator, enter the following to find YTC: N=52=10; PV=-1100; PMT=0.08/21,000=40; FV=1050; I/YR =YTC=?

"The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year10. This investment will cost the firm $140,000 today, and the firm's required rate of return is 10 percent. Assume cash flows occur evenly during the year, 1/365th each day. What is the payback period for this investment?"

YEAR 0 = (-140,000) YEAR 1 = 30000 YEAR 2 = 30000 YEAR 3 = 30000 YEAR 4 = 30000 YEAR 5 = 35000 YEAR 6 = 35000 YEAR 7 = 35000 YEAR 8 = 35000 YEAR 9 = 35000 YEAR 10 = 40000 TO FIND PAYBACK PERIOD: ADD UP YEARS TO GET CLOSE TO 140000 BUT DO NOT GO OVER YEAR 1 - 4 = 30000 X 4 = 120000 (IF WE CHOOSE TO ADD 35000 WE WOULD BE OVER 140000 BY 15000) SUBTRACT 140000 FROM 120000 = 20000 THEN TAKE THE YEARS YOU USED TO GET 120000 4 THEN TAKE THE 20000 LEFT FROM THE SUBTRACTION OF 120000 LEAVING 20000 USE YEAR 5 AS THE DENOMINATOR OF THE FOLLOWING EQUATION 4 + 20000/350000 ANSWER = 4.57 YEARS

. Which of the following statements is CORRECT? a. The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. b. If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations. c. If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks. d. An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant. e. A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.

d. An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.

Which of the following statements is CORRECT? a. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. b. An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks. c. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. d. An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks. e. An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks.

d. An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

Which of the following statements is CORRECT? a. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. b. A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. c. A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8. d. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. e. A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.

a. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.

If markets are in equilibrium, which of the following conditions will exist? a. Each stock's expected return should equal its required return as seen by the marginal investor. b. All stocks should have the same expected return as seen by the marginal investor. c. The expected and required returns on stocks and bonds should be equal. d. All stocks should have the same realized return during the coming year. e. Each stock's expected return should equal its realized return as seen by the marginal investor.

a. Each stock's expected return should equal its required return as seen by the marginal investor.

Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT? a. If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB. b. If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount. c. Since the market is in equilibrium, the required returns of the two stocks should be the same. d. If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase. e. If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase.

a. If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT? a. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. b. An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. c. If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. d. If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. e. Stock B's required return is double that of Stock A's.

a. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.

Bae Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

a. 0.67

Shirley Paul's 2-stock portfolio has a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is her portfolio's beta? a. 1.17 b. 1.23 c. 1.29 d. 1.35 e. 1.42

a. 1.17

Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta?

a. 1.17

Cheng Inc. is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%. What is the project's coefficient of variation?

a. 1.20

Fiske Roofing Supplies' stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.) a. 10.36% b. 10.62% c. 10.88% d. 11.15% e. 11.43%

a. 10.36%

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

a. 10.36%

Data for Atwill Corporation is shown below. Now Atwill acquires some risky assets that cause its beta to increase by 30%. In addition, expected inflation increases by 2.00%. What is the stock's new required rate of return? Initial beta 1.00 Initial required return (rs) 10.20% Market risk premium, RPM 6.00% Percentage increase in beta 30.00% Increase in inflation premium, IP 2.00% Data for Atwill Corporation is shown below. Now Atwill acquires some risky assets that cause its beta to increase by 30%. In addition, expected inflation increases by 2.00%. What is the stock's new required rate of return? Initial beta 1.00 Initial required return (rs) 10.20% Market risk premium, RPM 6.00% Percentage increase in beta 30.00% Increase in inflation premium, IP 2.00% a. 14.00% b. 14.70% c. 15.44% d. 16.21% e. 17.02%

a. 14.00%

Data for Dana Industries is shown below. Now Dana acquires some risky assets that cause its beta to increase by 30%. In addition, expected inflation increases by 2.00%. What is the stock's new required rate of return? Initial beta 1.00 Initial required return (rs) 10.20% Market risk premium, RPM 6.00% Percentage increase in beta 30.00% Increase in inflation premium, IP 2.00%

a. 14.00%

. Porter Plumbing's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.) a. 14.38% b. 14.74% c. 15.11% d. 15.49% e. 15.87%

a. 14.38%

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

a. 14.38%

Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium? a. 5.80% b. 5.95% c. 6.09% d. 6.25% e. 6.40%

a. 5.80%

Porter Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

a. 5.80%

Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. You now receive another $5.00 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)

a. 8.83%

Which of the following statements is CORRECT? a. A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. b. A two-stock portfolio will always have a lower beta than a one-stock portfolio. c. If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. d. A stock with an above-average standard deviation must also have an above-average beta. e. A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.

a. A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.

Which of the following statements is CORRECT? a. Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. b. If a company's beta were cut in half, then its required rate of return would also be halved. c. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase. d. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. e. If a company's beta doubles, then its required rate of return will also double.

d. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true, assuming the CAPM is correct. a. In equilibrium, the expected return on Stock B will be greater than that on Stock A. b. When held in isolation, Stock A has more risk than Stock B. c. Stock B would be a more desirable addition to a portfolio than A. d. In equilibrium, the expected return on Stock A will be greater than that on B. e. Stock A would be a more desirable addition to a portfolio then Stock B.

d. In equilibrium, the expected return on Stock A will be greater than that on B.

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

d. Portfolio AC has a standard deviation that is less than 25%.

Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.) a. Stock B has a higher required rate of return than Stock A. b. Portfolio P has a standard deviation of 22.5%. c. More information is needed to determine the portfolio's beta. d. Portfolio P has a beta of 1.0. e. Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.

d. Portfolio P has a beta of 1.0.

You have a portfolio P that consists of 50% Stock X and 50% Stock Y. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Given this information, which of the following statements is CORRECT? a. The required return on Portfolio P is equal to the market risk premium (rM − rRF). b. Portfolio P has a beta of 0.7. c. Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. d. Portfolio P has the same required return as the market (rM). e. Portfolio P has a standard deviation of 20%.

d. Portfolio P has the same required return as the market (rM).

Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRF. Meanwhile, investors are afraid of a recession, so the market risk premium, (rM − rRF), has increased. Under these conditions, with other things held constant, which of the following statements is most correct? a. The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. b. Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. c. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. d. The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. e. The required return on all stocks would increase by the same amount.

d. The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.

Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur? a. The required return on a stock with beta > 1.0 will increase. b. The return on "the market" will remain constant. c. The return on "the market" will increase. d. The required return on a stock with beta < 1.0 will decline. e. The required return on a stock with beta = 1.0 will not change.

d. The required return on a stock with beta < 1.0 will decline.

Which of the following statements is CORRECT? a. If the risk-free rate rises, then the market risk premium must also rise. b. If a company's beta is halved, then its required return will also be halved. c. If a company's beta doubles, then its required return will also double. d. The slope of the security market line is equal to the market risk premium, (rM − rRF). e. Beta is measured by the slope of the security market line.

d. The slope of the security market line is equal to the market risk premium, (rM − rRF).

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B? Years Market Stock A Stock B 1 0.03 0.16 0.05 2 -0.05 0.20 0.05 3 0.01 0.18 0.05 4 -0.10 0.25 0.05 5 0.06 0.14 0.05

d. bA < 0; bB = 0.

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then a. the past realized return must be equal to the expected return during the same period. b. the required return must equal the realized return in all periods. c. the expected return must be equal to both the required future return and the past realized return. d. the expected future returns must be equal to the required return. e. the expected future return must be less than the most recent past realized return.

d. the expected future returns must be equal to the required return.

Paul McLaren holds the following portfolio: Stock Investment Beta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total $375,000 Paul plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change? a. −0.190 b. −0.211 c. −0.234 d. −0.260 e. −0.286

d. −0.260

(Quiz/Sub#1)The Leeward Company just issued 15-year, 8 percent, unsecured bonds at par. These bonds fit the definition of which one of the following terms? note zero-coupon debenture discounted callable

debenture Feedback: Debenture = Unsecured. Mortgage = Secured.

(Quiz/Sub#2)The Walthers Company has a semi-annual coupon bond outstanding. An increase in the market rate of interest will have which one of the following effects on this bond? decrease the market price increase the time period increase the coupon rate decrease the coupon rate increase the market price

decrease the market price Feedback: Coupon rate and time period are set by the bond indenture. Only possible answers were increase or decrease price.

Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

e. 0.98

Donald Gilmore has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta? a. 0.65 b. 0.72 c. 0.80 d. 0.89 e. 0.98

e. 0.98

Jenna holds a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. Jenna plans to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be? a. 1.286 b. 1.255 c. 1.224 d. 1.194 e. 1.165

e. 1.165

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

e. 1.165

. Consider the following information and then calculate the required rate of return for the Universal Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows: Stock Investment Beta A $ 200,000 1.50 B $ 300,000 −0.50 C $ 500,000 1.25 D $1,000,000 0.75 a. 9.58% b. 10.09% c. 10.62% d. 11.18% e. 11.77%

e. 11.77%

Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows: Stock Investment Beta A $ 200,000 1.50 B 300,000 -0.50 C 500,000 1.25 D $1,000,000 0.75

e. 11.77%

Brodkey Shoes has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return? a. 13.51% b. 13.86% c. 14.21% d. 14.58% e. 14.95%

e. 14.95%

Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

e. 14.95%

Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

e. 3.38%

If you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect? a. Adding more such stocks will increase the portfolio's expected rate of return. b. Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. c. Adding more such stocks will have no effect on the portfolio's risk. d. Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk. e. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

e. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT? a. If a stock has a negative beta, its required return must also be negative. b. An index fund with beta = 1.0 should have a required return less than 11%. c. If a stock's beta doubles, its required return must also double. d. An index fund with beta = 1.0 should have a required return greater than 11%. e. An index fund with beta = 1.0 should have a required return of 11%.

e. An index fund with beta = 1.0 should have a required return of 11%.

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT? a. If a stock's beta doubled, its required return under the CAPM would also double. b. If a stock's beta doubled, its required return under the CAPM would more than double. c. If a stock's beta were 1.0, its required return under the CAPM would be 5%. d. If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%. e. If a stock has a negative beta, its required return under the CAPM would be less than 5%.

e. If a stock has a negative beta, its required return under the CAPM would be less than 5%.

Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM − rRF, is 6%. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is CORRECT? a. Since the two stocks have zero correlation, Portfolio AB is riskless. b. Stock B's beta is 1.0000. c. Portfolio AB's required return is 11%. d. Portfolio AB's standard deviation is 25%. e. Stock A's beta is 0.8333.

e. Stock A's beta is 0.8333.

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks? a. The expected return of your portfolio is likely to decline. b. The diversifiable risk will remain the same, but the market risk will likely decline. c. Both the diversifiable risk and the market risk of your portfolio are likely to decline. d. The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline. e. The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.

e. The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.

Which of the following are the factors for the Fama-French model? a. The excess market return, a debt factor, and a book-to-market factor. b. The excess market return, a size factor, and a debt. c. A debt factor, a size factor, and a book-to-market factor. d. The excess market return, an industrial production factor, and a book-to-market factor. e. The excess market return, a size factor, and a book-to-market factor.

e. The excess market return, a size factor, and a book-to-market factor. .

Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur? a. The required rate of return will decline for stocks whose betas are less than 1.0. b. The required rate of return on the market, rM, will not change as a result of these changes. c. The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk d. The required rate of return on a riskless bond will decline. e. The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

e. The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur? a. The required return would decrease by the same amount for both Stock A and Stock B. b. The required return would increase for Stock A but decrease for Stock B. c. The required return on Portfolio P would remain unchanged. d. The required return would increase for Stock B but decrease for Stock A. e. The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.

e. The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.

How would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse? a. The x-axis intercept would decline, and the slope would increase. b. The y-axis intercept would increase, and the slope would decline. c. The SML would be affected only if betas changed. d. Both the y-axis intercept and the slope would increase, leading to higher required returns. e. The y-axis intercept would decline, and the slope would increase.

e. The y-axis intercept would decline, and the slope would increase.

(Quiz/Sub#4)A sinking fund is managed by a trustee for which one of the following purposes? converting bonds into equity securities reducing coupon rates paying interest payments early bond redemption paying preferred dividends

early bond redemption Feedback: early redemption, making the bond less risky, as the trustee holds the funds to assure payback.

A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).

A stock with a beta equal to −1.0 has zero systematic (or market) risk.

An increase in accounts receivable represents an increase in net cash provided by operating activities because receivables will produce cash when they are collected.

Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.

Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a profit margin of 8% for Firm B. Firm A's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is 70% versus one of 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's higher profit margin.

The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their costs of capital.

The corporate valuation model can be used only when a company doesn't pay dividends.

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

"All else equal, risk averse investors generally require __________ returns to purchase investments with __________ risks"

higher;higher

The advantage of the payback period over other capital budgeting techniques is that

it is the simplest and oldest formal model to evaluate capital budgeting model

(Quiz/Sub#4)A Treasury yield curve plots Treasury interest rates relative to which one of the following? the risk-free rate market rates comparable corporate bond rates inflation maturity

maturity Feedback: ield/Rate on the y axis, and maturity on the x axis.

(EOCP-5-4)The real risk-free rate of interest is 4%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?

r* = 4%; I1 = 2%; I2 = 4%; I3 = 4%; MRP = 0; rT-2 = ?; rT-3 = ? r = r* + IP + DRP + LP + MRP. Since these are Treasury securities, DRP = LP = 0. rT-2 = r* + IP2IP2 = (2% + 4%)/2 = 3% rT-2 = 4% + 3% = 7%. rT-3 = r* + IP3IP3 = (2% + 4% + 4%)/3 = 3.33% rT-3 = 4% + 3.33% = 7.33%.

(EOCP-5-5)A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of 9%. Assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond?

rT-10 = 6%; rC-10 = 9%; LP = 0.5%; DRP = ? r = r* + IP + DRP + LP + MRP. rT-10 = 6% = r* + IP + MRP; DRP = LP = 0. rC-10 = 8% = r* + IP + DRP + 0.5% + MRP. Because both bonds are 10-year bonds the inflation premium and maturity risk premium on both bonds are equal. The only difference between them is the liquidity and default risk premiums. rC-10 = 9% = r* + IP + MRP + 0.5% + DRP. But we know from above that r* + IP + MRP = 6%; therefore, rC-10 = 9% = 6% + 0.5% + DRP 2.5% = DRP.

. For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.

. If a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

. The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities.

A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms.

Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher NPV.

Diversification will normally reduce the riskiness of a portfolio of stocks.

For a project with one initial cash outflow followed by a series of positive cash inflows, the modified IRR (MIRR) method involves compounding the cash inflows out to the end of the project's life, summing those compounded cash flows to form a terminal value (TV), and then finding the discount rate that causes the PV of the TV to equal the project's cost.

One advantage of the payback method for evaluating potential investments is that it provides information about a project's liquidity and risk.

Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the firm's total corporate value.

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

The NPV method's assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.

The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

The value of any asset is the present value of the cash flows the asset is expected to provide. The cash flows a business is able to provide to its investors is its free cash flow. This is the reason that FCF is so important in finance.

Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life.

(Quiz/Sub#1)The pure time value of money is known as the: liquidity effect. interest rate factor. inflation factor. Fisher effect term structure of interest rates

term structure of interest rates

(Quiz/Sub#4)An indenture is: another name for a bond's coupon. a bond that is secured by the inventory held by the bond's issuer. the written record of all the holders of a bond issue. a bond that is past its maturity date but has yet to be repaid. the legal agreement between the bond issuer and the bondholders.

the legal agreement between the bond issuer and the bondholders.

Net present value is preferred to internal rate of return for capital budgeting decisions because

the net present value allows you to compare mutually exclusive projects

Gardner Electric has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return? a. 11.34% b. 11.63% c. 11.92% d. 12.22% e. 12.52%

b. 11.63%

Nagel Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return?

b. 11.63%

Carson Inc.'s manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.) Economic Conditions Prob. Return Strong 30% 32.0% Normal 40% 10.0% Weak 30% -16.0%

b. 18.62%

Stuart Company's manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.) Economic Conditions Prob. Return Strong 30% 32.0% Normal 40% 10.0% Weak 30% −16.0% a. 17.69% b. 18.62% c. 19.55% d. 20.52% e. 21.55%

b. 18.62%

Returns for the Alcoff Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.) Year Return 2010 21.00% 2009 −12.50% 2008 25.00% a. 20.08% b. 20.59% c. 21.11% d. 21.64% e. 22.18%

b. 20.59%

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.) Year Return 2012 21.00% 2011 -12.50% 2010 25.00%

b. 20.59%

51. You are considering investing in one of the these three stocks: Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio. a. A; B. b. B; A. c. C; A. d. C; B. e. A; A.

b. B; A.

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT? a. Stock B's required rate of return is twice that of Stock A. b. If Stock A's required return is 11%, then the market risk premium is 5%. c. If Stock B's required return is 11%, then the market risk premium is 5%. d. If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's. e. If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's.

b. If Stock A's required return is 11%, then the market risk premium is 5%.

. Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to the CAPM? a. Stock Y's realized return during the coming year will be higher than Stock X's return. b. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount. c. Stock Y's return has a higher standard deviation than Stock X. d. If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. e. If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.

b. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.

True

"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities

(Quiz/Sub#1)The value of a 20 year zero-coupon bond when the market required rate of return of 9% (semiannual) is ____ . Correct Answer $171.93 $178.43 $318.38 $414.64 None of the above.

$171.93 Feedback: $1,000/(1.045)40 = $171.93 Face Value/(1 + r)^n =

Mike Flannery holds the following portfolio: Stock Investment Beta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total $375,000 What is the portfolio's beta?

1.17

(Quiz/Sub#3)Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%? 20-year, 10% coupon bond. 20-year, 5% coupon bond. 1-year, 10% coupon bond. 20-year, zero coupon bond.

20-year, zero coupon bond.

If interest rates fall from 8 percent to 7 percent, which of the following bonds will have the largest percentage increase in its value?

A 10-year zero coupon bond.

Which of the following statements is CORRECT?

A SECURITY'S BETA measures its non-diversifiable, or market, risk relative to that of an average stock.

True

A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions

False

A stock with a beta equal to -1.0 has zero systematic (or market) risk

Which of the following statements is CORRECT?

An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.

Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?

An index fund with beta = 1.0 should have a required return of 11%.

Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, and an 8% yield to maturity. Which of the following statements is CORRECT? a. Bond A's current yield is greater than that of Bond B. b. Bond A trades at a discount, whereas Bond B trades at a premium. c. Bond A's capital gains yield is greater than Bond B's capital gains yield. d. If the yield to maturity for both bonds remains at 8%, Bond A's price one year from now will be higher than it is today, but Bond B's price one year from now will be lower than it is today. e. If the yield to maturity for both bonds immediately decreases to 6%, Bond A's bond will have a larger percentage increase in value.

(Quiz/Sub#5)Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts interest rate risk to companies, it offers no advantages to issuers. True False

False Feedback: Floating rates can benefit issuers if rates decline, so a company that thinks rates are likely to fall would want to issue such bonds.

Which of the following statements is CORRECT?????

Capital market instruments include both long-term debt and common stocks.

Which of the following actions are not likely to reduce the agency problem between stockholders and managers?

Congress passes a law that severely restricts hostile takeovers.

Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?

Corporations step up their expansion plans and thus increase their demand for capital.

All things being equal, an increase in a firm's required rate of return would normally cause the firm's stock price to

Decrease.

Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

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

True

Diversification will normally reduce the riskiness of a portfolio of stocks.

"Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift"

Down and have steeper slope.

If a lower level person in a firm does something illegal, like "cooking the books" to understate costs and thereby increase profits above the correct profits because he or she was told to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted.

Beta is a measure of a stock's company-specific risk

FALSE

If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond? a. 2.53% b. 1.90% c. 2.09% d. 2.30% e. 2.78%

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

In EQUILIBRIUM, the expected return on Stock A will be greater than that on B.

True

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data

True

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

Jerome Corporation's bonds have 15 years to maturity, an 8.75% coupon paid semiannually, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,050. What is the bond's nominal yield to call? a. 5.01% b. 5.81% c. 5.27% d. 6.10% e. 5.54%

Kessen Inc.'s bonds mature in 7 years, have a par value of $1,000, and make an annual coupon payment of $70. The market interest rate for the bonds is 8.5%. What is the bond's price? a. $923.22 b. $1,019.06 c. $946.30 d. $994.21 e. $969.96

False

Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.

Which of the following statements is CORRECT

Most business (measured by dollar sales) is conducted by corporations in spite of large corporations' often less favorable tax treatment, due to legal considerations related to ownership transfers and limited liability.

(Quiz/Sub#5)Face value is always higher than current price. always lower than current price. the same as the current price. the coupon amount. None of the above.

None of the above. Feedback: Face Value is is the amount of money needed to be repaid at the end of the bond's life. (aka Par Value)

(Quiz/Sub#2)Which of the following statements is most correct? If a bond sells for less than par, then its yield to maturity is less than its coupon rate. If a bond sells at par, then its current yield will be less than its yield to maturity. Assuming that both bonds are held to maturity and are of equal risk, a bond selling for more than par with ten years to maturity will have a lower current yield and higher capital gain relative to a bond that sells at par. Answers a and c are correct. None of the answers above is correct.

None of the answers above is correct. Feedback: See Book

Which of the following statements is most correct?h

None of the statements above is correct.

Perry Inc.'s bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and a par value of $1,000. What is their current yield? a. 7.76% b. 8.15% c. 8.98% d. 7.39% e. 8.56%

Which of the following statements is most correct?=

Preferred stockholders have priority over common stockholders.

True

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse

See Excel Tool Kit for Section Problems

See book and end of Chapter Solutions for Problems 9 - 18

Money markets are markets for

Short-term debt securities.

True

Since the market return represents the expected return on an average stock, the market return reflects a certain amount of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is required to compensate stock investors for assuming an average amount of risk.

Which of the following statements is CORRECT?

Suppose the RETURNS on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year PERIOD.

Prices would decline and interest rates would rise.

Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds. Assuming the announcement was not expected, what effect, other things held constant, would that have on bond prices and interest rates?

Which of the following statements is CORRECT?

Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well diversified investor, assuming investors expect the observed relationship to continue on into the future.

In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false?

The BETA of the portfolio is LOWER than the lowest of the three betas.

The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT? a. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year. b. Bond A's current yield will increase each year. c. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity. d. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year. e. Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase.

True

The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

Which of the following statements is most correct?y

The preemptive right is a provision in the corporate charter which gives common stockholders the right to purchase (on a pro rata basis) new issues of common stock.

Which of the following statements is most correct?k

The price of a discount bond will increase over time, assuming that the bond's yield to maturity remains constant over time.

False

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

True

The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

Which of the following mechanisms is used to motivate managers to act in the interests of shareholders?

The threat of a takeover. AND Executive stock options.

Which of the following statements is CORRECT? a. The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders. b. The threat of takeovers tends to reduce potential conflicts between stockholders and managers. c. Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers. d. One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm's capital structure. e. The threat of takeover generally increases potential conflicts between stockholders and managers.

The threat of takeovers tends to reduce potential conflicts between stockholders and managers.

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

Your portfolio has a beta equal to 1.6, and its expected return is 15%.

Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year non-callable, long-term debt in 2014. As of the end of 2015, none of the principal on this debt had been repaid. Assume that the company's sales in 2014 and 2015 were the same. Which of the following statements must be CORRECT? a. Wolken had negative net income in 2015. b. Wolken issued new common stock in 2015. c. Wolken increased its short-term bank debt in 2015. d. Wolken issued long-term debt in 2015. e. Wolken repurchased some common stock in 2015.

Suppose Stan holds a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose Stan decided to sell one of his stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be? a. 1.17 b. 1.23 c. 1.29 d. 1.36 e. 1.43

c. 1.29

Suppose you hold a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose you decided to sell one of your stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be?

c. 1.29

Cooley Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?

c. 11.95%

Consider the following average annual returns for Stocks A and B and the Market. Which of the possible answers best describes the historical betas for A and B? Years Market Stock A Stock B 1 0.03 0.16 0.05 2 −0.05 0.20 0.05 3 0.01 0.18 0.05 4 −0.10 0.25 0.05 5 0.06 0.14 0.05 a. bA > +1; bB = 0. b. bA = 0; bB = −1. c. bA < 0; bB = 0. d. bA < −1; bB = 1. e. bA > 0; bB = 1.

c. bA < 0; bB = 0.

Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

coefficient of variation; Beta

Tom Noel holds the following portfolio: Stock Investment Beta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total $375,000 Tom plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change?

d. -0.260

Barker Corp. has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Barker's required rate of return? a. 9.43% b. 9.67% c. 9.92% d. 10.17% e. 10.42%

d. 10.17%

According to the valuation model, if investors perceive a particular company to be very risky, its value will

decrease

Discounted payback's primary advantage over traditional payback is that

discounted payback does consider the time value of money

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant? a. The required return on both stocks would increase by 1%. b. The required return on Portfolio P would remain unchanged. c. The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%. d. The required return for Stock A would fall, but the required return for Stock B would increase. e. The required return on Portfolio P would increase by 1%.

e. The required return on Portfolio P would increase by 1%.

Which of the following statements is CORRECT? a. Lower beta stocks have higher required returns. b. A stock's beta indicates its diversifiable risk. c. Diversifiable risk cannot be completely diversified away. d. Two securities with the same stand-alone risk must have the same betas. e. The slope of the security market line is equal to the market risk premium.

e. The slope of the security market line is equal to the market risk premium.

A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid.

Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors.

Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values of cash flows should not be summed to determine the value of a capital budgeting project.

Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes.

EBITDA stands for earnings before interest, taxes, debt, and assets.

High current and quick ratios always indicate that the firm is managing its liquidity position well.

In order to maximize its shareholders' value, a firm's management must attempt to maximize the expected EPS.

One of the basic relationships in interest rate theory is that, other things held constant, for a given change in the required rate of return, the the time to maturity, the the change in price.

longer; greater.

"Steve Brickson currently has an investment portfolio that contains four stocks with a total value equal to $70,000. The portfolio has a beta (b) equal to 1.4. Steve wants to invest an additional $30,000 in a stock that has b = 2.4. After Steve adds the new stock to his portfolio, what will be the portfolio's beta?"

portifolio beta = (70000/100000) * 1.4 + (30000/100000) * 2.4 = 1.7 ANSWER: 1.7

The __________ involves comparing the actual results with those predicted by the project's sponsors and explaining why any differences occur

post-audit

(EOCP-5-6)The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2- year Treasury security yields 6.3%. What is the maturity risk premium for the 2-year security?

r* = 3%; IP = 3%; rT-2 = 6.3%; MRP2 = ? rT-2 = r* + IP + MRP = 6.3% rT-2 = 3% + 3% + MRP = 6.3% MRP = 0.3%

Portfolio P has equal amounts invested in each of the three stocks, A, B, and C. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT? a. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium. b. The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease. c. The required returns on all three stocks will increase by the amount of the increase in the market risk premium. d. The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase. e. The required return of all stocks will remain unchanged since there was no change in their betas.

a. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

Assume that in recent years both expected inflation and the market risk premium (rM − rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes? a. The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas. b. The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. c. Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. d. The required returns on all stocks have fallen by the same amount. e. The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas.

a. The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $300,000 invested in Stock A and $100,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT? a. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. b. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. c. Portfolio AB's expected return is 11.0%. d. Portfolio AB's beta is less than 1.2. e. Portfolio AB's standard deviation is 17.5%.

a. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.

(Quiz/Sub#5)Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment at maturity. What is the $1,000 called? Incorrect Response face value par value principal all of the above.

all of the above.

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.

Roenfeld Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock? Probability Stock's State of of State Expected the Economy Occurring Return Boom 0.45 25% Normal 0.50 15% Recession 0.05 5%

b. 0.3069

Jim Angel holds a $200,000 portfolio consisting of the following stocks: Stock Investment Beta A $ 50,000 0.95 B 50,000 0.80 C 50,000 1.00 D 50,000 1.20 Total $200,000

b. 0.988

Martin Ortner holds a $200,000 portfolio consisting of the following stocks: Stock Investment Beta A $50,000 0.95 B 50,000 0.80 C 50,000 1.00 D 50,000 1.20 Total $200,000 What is the portfolio's beta? a. 0.938 b. 0.988 c. 1.037 d. 1.089 e. 1.143

b. 0.988

Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. Stock Investment Beta A $ 50,000 0.50 B 50,000 0.80 C 50,000 1.00 D 50,000 1.20 Total $200,000 If Jill replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

b. 1.13

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. Stock Investment Beta A $50,000 0.50 B 50,000 0.80 C 50,000 1.00 D 50,000 1.20 Total $200,000 If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be? a. 1.07 b. 1.13 c. 1.18 d. 1.24 e. 1.30

b. 1.13

Megan Ross holds the following portfolio: Stock Investment Beta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total $375,000 What is the portfolio's beta? a. 1.06 b. 1.17 c. 1.29 d. 1.42 e. 1.56

b. 1.17

A mutual fund manager has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. The manager expects to receive an additional $60 million which she plans to invest in additional stocks. After investing the additional funds, she wants the fund's required and expected return to be 13.00%. What must the average beta of the new stocks be to achieve the target required rate of return?

b. 1.76

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 13.0% and a beta of 1.50. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock?

b. 11.20%; 1.23

Ivan Knobel holds a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. He is in the process of buying 1,000 shares of Syngine Corp at $10 a share and adding it to his portfolio. Syngine has an expected return of 13.0% and a beta of 1.50. The total value of Ivan's current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Syngine stock? a. 10.64%; 1.17 b. 11.20%; 1.23 c. 11.76%; 1.29 d. 12.35%; 1.36 e. 12.97%; 1.42

b. 11.20%; 1.23

(Quiz/Sub#3)Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? Hint, the closest answer without going over the bonds value is correct. $619 $674 $761 $828 $902

$828 Feedback: Financial calculator solution:Inputs: N = 40; I = 5; PMT = 40; FV = 1,000. Output: PV = -$828.41; VB ÷ $828. Bond value - semiannual payment

(Quiz/Sub#5)Rogoff Co.'s 15-year bonds have an annual coupon rate of 9.5%. Each bond has face value of $1,000 and makes semiannual interest payments. If you require an 11.0% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? $891.00 $913.27 $936.10 $959.51

$891.00 Feedback: N=15*2=30 I=11/2=5.5 FIND PV=-890.9969 PMT=(9.5%*1000)/2=47.5 FV=1000

(Quiz/Sub#5)Noncallable bonds that mature in 10 years were recently issued by Sternglass Inc. They have a par value of $1,000 and an annual coupon of 5.5%. If the current market interest rate is 7.0%, at what price should the bonds sell? $829.21 $850.47 $872.28 $894.65

$894.65 Feedback: N=10 I=7 FIND PV=-894.646 PMT=5.5%*1000=55 FV=1000

(Quiz/Sub#2)Kessen Inc.'s bonds mature in 7 years, have a par value of $1,000, and make an annual coupon payment of $70. The market interest rate for the bonds is 8.5%. What is the bond's price? $923.22 $946.30 $969.96 $994.21

$923.22 N=7 I=8.5 PV=-923.22 PMT=70 FV=1000

(EOCP-5-1)Jackson Corporation's bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 9%. What is the current market price of these bonds?

$928.39 N = 12; I/YR = YTM = 9%; PMT = 0.08 1,000 = 80; FV = 1000; PV = VB = ? PV = $928.39. Alternatively, VB = $80((1- 1/1.0912)/0.09) + $1,000(1/1.0912) = $928.39

(Quiz/Sub#2)One of the basic relationships in interest rate theory is that, other things held constant, for a given change in the required rate of return, the_____________the time to maturity, the__________the change in price. longer; smaller. shorter; larger. longer; greater. shorter; smaller. Answers c and d are correct.

Answers c and d are correct.

True

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

(Quiz/Sub#3)Roadside Markets has a 6.75 percent coupon bond outstanding that matures in 10.5 years. The bond pays interest semiannually. What is the market price per bond if the face value is $1,000 and the yield to maturity is 7.2 percent? $899.85 $967.24 $903.42 $899.80 $1,007.52

$967.24 Roadside Markets has a 6.75 (6.75%*1000=67.50/2=33.75=pmt) percent coupon bond outstanding that matures in 10.5 (10.5*2=21) years. The bond pays interest semiannually. What is the market price per bond if the face value is $1,000 (=fv) and the yield to maturity is 7.2 percent (7.2/2=3.6=i)? Solve for pv = -967.24 .

(Quiz/Sub#4)Oil Well Supply offers 7.5 percent coupon bonds with semiannual payments and a yield to maturity of 7.68 percent. The bonds mature in 6 years. What is the market price per bond if the face value is $1,000? $1,002.60 $1,013.48 $989.70 $996.48 $991.47

$991.47 Feedback: Oil Well Supply offers 7.5 percent coupon (7.5%*1000=75/2=37.5=pmt) bonds with semiannual payments and a yield to maturity of 7.68 (7.68/2=3.84=i)percent. The bonds mature in 6 (6*2=12=n( years. What is the market price per bond if the face value is $1,000 (=fv)? solve for pv=991.47

121. Shirley Paul's 2-stock portfolio has a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is her portfolio's beta?

(A) 1.17

139. Fiske Roofing Supplies' stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

(A) 10.36%

138. Data for Atwill Corporation is shown below. Now Atwill acquires some risky assets that cause its beta to increase by 30%. In addition, expected inflation increases by 2.00%. What is the stock's new required rate of return? Initial beta 1.00 Initial required return (rs) 10.20% Market risk premium, RPM 6.00% Percentage increase in beta 30.00% Increase in inflation premium, IP 2.00%

(A) 14.00%

131. Porter Plumbing's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

(A) 14.38%

125. Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

(A) 5.80%

144. The $10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. Henry now receives another $5.00 million, which he invests in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint:=You must first find the market risk premium, then find the new portfolio beta.)

(A) 8.83%

66. Which of the following statements is CORRECT?

(A) A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.

68. Which of the following statements is CORRECT?

(A) A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.

110. You observe the following information regarding Companies X and Y: ∙ Company X has a higher expected return than Company Y. ∙ Company X has a lower standard deviation of returns than Company Y. ∙ Company X has a higher beta than Company Y. Given this information, which of the following statements is CORRECT?

(A) Company X has a lower coefficient of variation than Company Y.

65. Which of the following statements is CORRECT?

(A) Diversifiable risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk.

. If markets are in equilibrium, which of the following conditions will exist?

(A) Each stock's expected return should equal its required return as seen by the marginal investor.

89. Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

(A) If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.

80. Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

(A) If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.

56. Which of the following statements is CORRECT?

(A) Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.

71. Charlie and Lucinda each have $50,000 invested in stock portfolios. Charlie's has a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Lucinda's has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Charlie's and Lucinda's portfolios is zero. If Charlie and Lucinda marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

(A) The combined portfolio's beta will be EQUAL TO a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be EQUAL TO a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be LESS THAN the simple average of the two portfolios' standard deviations, 25%.

77. Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. Your portfolio consists of 50% A and 50% B. Which of the following statements is CORRECT?

(A) The portfolio's expected return is 15%.

90. Portfolio P has equal amounts invested in each of the three stocks, A, B, and C. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?

(A) The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

87. Assume that in recent years both expected inflation and the market risk premium (rM − rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?

(A) The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.

81. Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $300,000 invested in Stock A and $100,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT?

(A) The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.

126. Martin Ortner holds a $200,000 portfolio consisting of the following stocks: Stock Investment Beta A $50,000 0.95 B 50,000 0.80 C 50,000 1.00 D 50,000 1.20 Total $200,000 What is the portfolio's beta?

(B) 0.988

127. Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. Stock Investment Beta A $50,000 0.50 B 50,000 0.80 C 50,000 1.00 D 50,000 1.20 Total $200,000 If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

(B) 1.13

128. Megan Ross holds the following portfolio: Stock Investment Beta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total $375,000 What is the portfolio's beta?

(B) 1.17

145. Hazel Morrison, a mutual fund manager, has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. Hazel expects to receive an additional $60 million, which she plans to invest in additional stocks. After investing the additional funds, she wants the fund's required and expected return to be 13.00%. What must the average beta of the new stocks be to achieve the target required rate of return?

(B) 1.76

122. Ivan Knobel holds a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. He is in the process of buying 1,000 shares of Syngine Corp at $10 a share and adding it to his portfolio. Syngine has an expected return of 13.0% and a beta of 1.50. The total value of Ivan's current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Syngine stock?

(B) 11.20%; 1.23

136. Gardner Electric has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return?

(B) 11.63%

142. Stuart Company's manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.) Economic Conditions Prob. Return Strong 30% 32.0% Normal 40% 10.0% Weak 30%−16.0%

(B) 18.62%

141. Returns for the Alcoff Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.) Year Return 2010 21.00% 2009 −12.50% 2008 25.00%

(B) 20.59%

(B) B; A.

86. The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?

(B) If Stock A's required return is 11%, then the market risk premium is 5%.

59. Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to the CAPM?

(B) If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.

62. Which of the following statements is CORRECT?

(B) If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.

116. Portfolio AB was created by investing in a combination of Stocks A and B. Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?

(B) Portfolio AB has more money invested in Stock A than in Stock B.

111. Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P has 50% invested in Stock A and 50% invested in B. Which of the following statements is CORRECT?

(B) Portfolio P has more market risk than Stock A but less market risk than B.

84. In historical data, we see that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?

(B) Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

52. Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

(B) Stock B.

101. Which of the following statements is CORRECT?

(B) Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future.

55. Which of the following statements is CORRECT?

(B) The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.

53. Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

(B) The beta of an "average stock," or "the market," can change over time, sometimes drastically.

79. In a portfolio of three randomly selected stocks, which of the following could NOT be true; i.e., which statement is false?

(B) The beta of the portfolio is lower than the lowest of the three betas.

85. Suppose that during the coming year, the risk free rate, rRF, is expected to remain the same, while the market risk premium (rM − rRF), is expected to fall. Given this forecast, which of the following statements is CORRECT?

(B) The required return will fall for all stocks, but it will fall MORE for stocks with higher betas.

74. Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

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

72. The two stocks in your portfolio, X and Y, have independent returns, so the correlation between them, rXY is zero. Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. Which of the following statements best describes the characteristics of your 2-stock portfolio?

(B) Your portfolio has a beta equal to 1.6, and its expected return is 15%.

63. Recession, inflation, and high interest rates are economic events that are best characterized as being

(B) among the factors that are responsible for market risk.

140. Suppose Stan holds a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose Stan decided to sell one of his stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be?

146. Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect (and require) on this fund?Stock Amount Beta A $1,075,000 1.20 B 675,000 0.50 C 750,000 1.40 D 500,000 0.75 $3,000,000

124. Zacher Co.'s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?

147. DHF Company has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the riskfree rate change. What would DHF's new required return be?

133. Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

118. Freedman Flowers' stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a −28% return. What is the firm's expected rate of return?

97. Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

(C) If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.

83. Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

(C) If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.

96. Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%. Which of the following statements is CORRECT?

(C) If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.

114. Gretta's portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. The risk-free rate is 6% and the market risk premium is 5%. Which of the following statements is CORRECT?

(C) If the risk-free rate remains unchanged but the market risk premium increases by 2%, Gretta's portfolio's required return will increase by more than 2%.

67. Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. Expected Standard Stock Return Deviation Beta A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT?

75. Stocks A and B are quite similar: Each has an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?

78. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero.Assuming the market is in equilibrium, which of the following statements is CORRECT?

109. Which of the following statements is CORRECT?

(C) The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.

69. Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks?

108. For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

54. Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securities? (Assume market equilibrium.)

104. Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRF. Meanwhile, investors are afraid of a recession, so the market risk premium, (rM − rRF), has increased. Under these conditions, with other things held constant, which of the following statements is most correct?

103. Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines, with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

(C) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.

60. Consider the following average annual returns for Stocks A and B and the Market. Which of the possible answers best describes the historical betas for A and B? Years Market Stock A Stock B 1 0.03 0.16 0.05 2 −0.05 0.20 0.05 3 0.01 0.18 0.05 4 −0.10 0.25 0.05 5 0.06 0.14 0.05

134. Barker Corp. has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Barker's required rate of return?

(D) 10.17%

123. Calculate the required rate of return for Everest Expeditions Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.

(D) 12.00%

143. Assume that your cousin holds just one stock, Eastman Chemical Bonding (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for Wilder's Creations and Buildings (WCB). Both companies have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would your cousin's risk have been reduced if he had held a portfolio consisting of 60% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.)Year ECB WCB 2011 40.00% 40.00% 2012 −10.00% 15.00% 2013 35.00% −5.00% 2014 −5.00% −10.00% 2015 15.00% 35.00% Average return = 15.00% 15.00% Standard deviation = 22.64% 22.64%

(D) 3.84%

119. Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return. What is the firm's expected rate of return?

(D) 9.00%

64. Which of the following statements is CORRECT?

(D) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

107. Which of the following statements is CORRECT?

(D) An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.

61.Which of the following statements is CORRECT?

(D) An investor can eliminate almost all diversifiable risk if he or she holds a very large, well diversified portfolio of stocks.

117. Which of the following statements is CORRECT?

(D) Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1- year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

57. Which of the following statements is CORRECT?

(D) During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

105. Which of the following statements is CORRECT?

(D) If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.

91. Which of the following statements is CORRECT?

(D) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

58. Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true, assuming the CAPM is correct.

(D) In equilibrium, the expected return on Stock A will be greater than that on B.

76. Stocks A, B, and C are similar in some respects: Each has an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another; i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another; i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT?

(D) Portfolio AC has a standard deviation that is less than 25%.

95. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

(D) Portfolio P has a beta of 1.0.

82. You have a portfolio P that consists of 50% Stock X and 50% Stock Y. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Given this information, which of the following statements is CORRECT?

(D) Portfolio P has the same required return as the market (rM).

100. Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?

(D) The required return on a stock with beta < 1.0 will decline.

94. Which of the following statements is CORRECT?

(D) The slope of the security market line is equal to the market risk premium, (rM − rRF).

112. For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

(D) the expected future returns must be equal to the required return.

129. Paul McLaren holds the following portfolio: Stock Investment Beta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total $375,000 Paul plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change?

(D) −0.260

120. Donald Gilmore has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

(E) 0.98

130. Jenna holds a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. Jenna plans to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

(E) 1.165

137. Consider the following information and then calculate the required rate of return for the Universal Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows: Stock Investment Beta A $ 200,000 1.50 B $ 300,000 −0.50 C $ 500,000 1.25 D $1,000,000 0.75

(E) 11.77%

135. Brodkey Shoes has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return

(E) 14.95%

132. Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

(E) 3.38%

70. If you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect?

(E) Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

92. Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?

(E) An index fund with beta = 1.0 should have a required return of 11%.

88. Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

(E) If a stock has a negative beta, its required return under the CAPM would be less than 5%.

115. Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM − rRF, is 6%. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is CORRECT?

(E) Stock A's beta is 0.8333.

73. Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?

(E) The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.

113. Which of the following are the factors for the Fama-French model?

(E) The excess market return, a size factor, and a book-to-market factor.

106. Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur?

(E) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

99. Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

(E) The required return on Portfolio P would increase by 1%.

98. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the riskfree rate (rRF) remained constant, which of the following would occur?

(E) The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.

93. Which of the following statements is CORRECT?

(E) The slope of the security market line is equal to the market risk premium.

102. How would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse?

(E) The y-axis intercept would decline, and the slope would increase.

(Quiz/Sub#3)Haswell Enterprises' bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond's price? 1,063.09 1,090.35 1,118.31 1,146.27

1,118.31 Feedback: N=10*2=20 I=4.75 Find PV=-1118.31 PMT=(6.25%*1000)/2=31.25 FV=1000

(Quiz/Sub#5)Chandler Co.'s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Chandler's bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) ´ 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Chandler's bonds? 0.99% 1.10% 1.21% 1.33%

1.10% Feedback: Find the difference between Chandler's bond and the T-Bonds =7%-5.15% =1.85% Then subtract the liquidity premium of .75% =1.85%-.75% =1.1% The other factors were already accounted for when we found the difference between Chandler's bonds and the T-Bonds.

(Quiz/Sub#1)The Gergen Group's 5-year bonds yield 6.85%, and 5-year T-bonds yield 4.75%. The real risk-free rate is r* = 2.80%, the default risk premium for Gergen's bonds is DRP = 0.85% versus zero for T-bonds, the liquidity premium on Gergen's bonds is LP = 1.25%, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) ´ 0.1%, where t = number of years to maturity. What is the inflation premium (IP) on 5-year bonds? 1.40% 1.55% 1.71% 1.88%

1.55% Feedback: Quoted Market Interest rate=real risk free rate of interest+Inflation Premium+Default risk premium+Liquidity Premium+Maturity risk premium 6.85%=2.8%+IP+.85%+1.25%+.4% =1.55% MRP=(5-1)*.1% =.4%

(Quiz/Sub#4)A corporate bond with a face value of $1,000 matures in 4 years and has a 8% coupon paid at the end of each year. The current price of the bond is $932. What is the yield to maturity for this bond? 5.05% 6.48% 8.58% 10.15% 11.92%

10.15% Feedback: Current Price = Int(PVIFAr,4) + Face value(PVIFr,4) $932 = $80[1-1/(1+r)4]/r + $1000/(1+r)4 r = 10.152 or Yield to Maturity can be calculated with a financial calculator:Input: N=4, PV=-932, PMT= 80 (calculated by multiplying FV*8%), FV=1000, Make sure it is in END mode.Output: I

(EOCP-5-2)Wilson Corporation's bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 10%. The bonds sell at a price of $850. What is their yield to maturity?

12.48%. N = 12; PV = -850; PMT = 0.10 1,000 = 100; FV = 1000; I/YR = YTM = ? YTM = 12.48%.

"If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J?"

13= 7+Beta(10-7) Beta= 2 ANSWER: 2

The capital budgeting director of Sparrow Corporation is evaluating a project which costs $94,641.50, is expected to last for 4 years and produce after-tax cash flows, including depreciation, of $34,500 per year. If the firm's required rate of return is 14 percent and its tax rate is 40 percent, what is the project's IRR?

17%

(Quiz/Sub#5)5-year Treasury bonds yield 5.5%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year bonds is 0.4%. What is the real risk-free rate, r*? 2.59% 2.88% 3.20% 3.52%

3.20% Feedback: Quoted Market Interest rate=Risk Free+IP+DRP+LP+MRP 5.5%=Real risk free+1.9%+.4% =3.2% Treasury bonds dent include default risk premium or liquidity premiums

(Quiz/Sub#1)Cold Boxes Ltd. has 100 bonds outstanding (maturity value = $1,000). The nominal required rate of return on these bonds is currently 10 percent, and interest is paid semiannually. The bonds mature in 5 years, and their current market value is $768 per bond. What is the annual coupon interest rate? 8% 6% 4% 2% 0%

4% Feedback: Financial calculator solution:Inputs: N = 10; I = 5; PV = -768; FV = 1,000.Output: PMT = $19.955 (semiannual PMT).Annual coupon rate = PMT x 2/M = $19.955 x 2/1,000 = 3.99% 247; 4%.

(Quiz/Sub#5)Gilligan Co.'s bonds currently sell for $1,150. They have a 6.75% annual coupon rate and a 15-year maturity, and are callable in 6 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds, the YTC or the YTM? 3.92% 4.12% 4.57% 4.81%

4.81% Feedback: See Quiz Feedback

(Quiz/Sub#2)What is the value of a 7 year bond that makes no coupon payments (0-coupon) with a yield to maturity (quoted rate) of 13.5 % and a maturity value of $1000? Note, I know the question says bond, but it actually is a simple present-value problem. Calculate your answer to the nearest $.01. Enter your answer as a postive number.

412.13 FV=1000, N=number of years, PMT=0, I= interest rate, then compute the Present Value/Price

(Quiz/Sub#4)Jerome Corporation's bonds have 15 years to maturity, an 8.75% coupon paid semiannually, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,050. What is the bond's nominal yield to call? 5.01% 5.27% 5.54% 5.81%

5.27% This problem requires two calculations First we need to find the present value of the bond N=15*2=30 I=6.5/2=3.25 PV=-1213.55 PMT=(8.75%*1000)/2=43.75 FV=1000 Then find the bond's yield to call N=6*2=12 I=2.635 PV=-1213.55 PMT=43.75 FV=1050 2.635% is semi annual 2.635%*2=5.27%

(Quiz/Sub#3)Sentry Corp. bonds have an annual coupon payment of 7.25%. The bonds have a par value of $1,000, a current price of $1,125, and they will mature in 13 years. What is the yield to maturity on these bonds? 5.56% 5.85% 6.14% 6.45%

5.85% Feedback: N=13 Find I=5.85 PV=-1125 PMT=7.25%*1000=72.5 FV=1000

(Quiz/Sub#2)Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest paid semiannually. The required nominal rate on this debt has now risen to 16 percent. What is the current value of this bond? $1,273 $1,000 $7,783 $ 550 $ 450

550 Financial calculator solution:Inputs: N = 30; I = 8; PMT = 40; FV = 1,000. Output: PV = -$549.69; VB = $549.69 247; $550.

Charleston Corporation (CC) now operates as a "regular" corporation, but it is considering a switch to S Corporation status. CC is owned by 100 stockholders who each hold 1% of the stock, and each faces a personal tax rate of 35%. The firm earns $2,800,000 per year before taxes, and since it has no need for retained earnings, it pays out all of its earnings as dividends. Assume that the corporate tax rate is 34% and the personal tax rate is 35%. How much more (or less) spendable income would each stockholder have if the firm elected S Corporation status?

6,188 Calculate S Corp Status Corporate Rate 34% = 2,800,000 * 0.66 = 952,000 to distribute to 100 stockholders. 952,000/100 = 9,520 Now each stockholder pays taxes at 35% 9520 * 0.65 = 6,188 Double Taxed at the Corporate/Personal Levels

(Quiz/Sub#1)Perry Inc.'s bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and a par value of $1,000. What is their current yield? 7.39% 7.76% 8.15% 8.56%

7.39% Feedback: Current Yield=Coupon/Current price of bond =85/1150 =.0739 =7.39%

(Quiz/Sub#4)Meacham Enterprises' bonds currently sell for $1,280 and have a par value of $1,000. They pay a $135 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,050. What is their yield to call (YTC)? 6.39% 6.72% 7.08% 7.45%

7.45% Feedback: N=5 Find I=7.45 PV=-1280 PMT=135 FV=1050

(Quiz/Sub#5)Field Industries' outstanding bonds have a 25-year maturity and $1,000 par value. Their nominal yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $850. What is the bond's nominal (annual) coupon interest rate? 6.27% 6.60% 6.95% 7.70%

7.70% Feedback: N=25*2=50 I=9.25/2=4.625 PV=-850 PMT=38.50 FV=1000 After you find the coupon, multiple it by two because this is a semi annual bond and we need the annual coupon. then to find percentage 77/1000=7.7%

(Quiz/Sub#3)Consider a $1,000 par value bond with a 7 percent annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10 percent? 10.00% 8.46% 7.00% 8.52% 8.37%

8.46% Feedback: Financial calculator solution:N = 9, I = 10, PMT = 70, FV = 1,000, and solve for PV = ? = -$827.23. Current yield = $70/$827.23 = 8.46%.

(Quiz/Sub#4)The bonds issued by Stainless Tubs bear an 8 percent coupon, payable semiannually. The bonds mature in 11 years and have a $1,000 face value. Currently, the bonds sell for $952. What is the yield to maturity? 9.20 percent 7.87 percent 7.92 percent 8.69 percent 8.08 percent

8.69 percent Feedback: pv=-952, fv=1000, n=11*22, pmt=80/2=40, solve for I=4.35. This is a 6 month rate, so double it for the yield to maturity of 8.69

(Quiz/Sub#4)Sommers Co.'s bonds currently sell for $1,080 and have a par value of $1,000. They pay a $100 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,125. What is their yield to maturity (YTM)? 8.56% 9.01% 9.46% 9.93%

9.01% Feedback: N=15 FIND I=9.007 PV=-1080 PMT=100 FV=1000

(Quiz/Sub#1)Collingwood Homes has a bond issue outstanding that pays an 8.5 percent coupon and matures in 16.5 years. The bonds have a par value of $1,000 and a market price of $944.30. Interest is paid semiannually. What is the yield to maturity? 8.61 percent 8.36 percent 8.42 percent 9.16 percent 8.74 percent

9.16 percent Feedback: Collingwood Homes has a bond issue outstanding that pays an 8.5 percent coupon (8.5*1000=$85/2=42.50=pmt) and matures in 16.5 (16.5*2=33=n) years. The bonds have a par value of $1,000 (=fv) and a market price of $944.30 (pv=-944.30). Interest is paid semiannually. What is the yield to maturity? Now, solve for I=4.58, double this, since semi-annual, to find ytm = 9.16%.

A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT? a. If the yield to maturity remains at 8%, then the bond's price will decline over the next year. b. If the yield to maturity increases, then the bond's price will increase. c. The bond's current yield is less than 8%. d. If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year. e. The bond's coupon rate is less than 8%.

A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT? a. If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price. b. If the yield to maturity remains constant, the bond's price one year from now will be higher than its current price. c. The bond's current yield is greater than 9%. d. The bond is selling below its par value. e. The bond is selling at a discount.

A 25-year, $1,000 par value bond has an 8.5% annual coupon. The bond currently sells for $875. If the yield to maturity remains at its current rate, what will the price be 5 years from now? a. $927.60 b. $882.90 c. $904.97 d. $860.83 e. $839.31

(Quiz/Sub#3)Which of the following statements is NOT CORRECT The expected return on a corporate bond must be less than its promised return if the probability of default is greater than zero. All else equal, senior debt has less default risk than subordinated debt. A company's bond rating is affected by its financial ratios and provisions in its indenture. Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off its debt according to the seniority of the debt as spelled out in the Act.

A company's bond rating is affected by its financial ratios and provisions in its indenture.

Which of the following statements is CORRECT?

A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.

Which of the following statements is CORRECT?

A portfolio with a large number of randomly selected stocks would have MORE market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.

Which of the following statements is CORRECT? a. A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. b. If a stock has a negative beta, its expected return must be negative. c. A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5. d. According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. e. If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.

A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.

False

A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?

A reduction in market interest rates.

False

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio

False

A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms

Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet? a. The company issues new common stock. b. The company pays a dividend. c. The company repurchases common stock. d. The company purchases a new piece of equipment.

Assume that interest rates on 15-year noncallable Treasury and corporate bonds with different ratings are as follows: T-bond = 7.72% A = 9.64% AAA = 8.72% BBB = 10.18% The differences in rates among these issues were most probably caused primarily by: a. Maturity risk differences. b. Real risk-free rate differences. c. Tax effects. d. Inflation differences. e. Default risk differences.

Which of the following statements is CORRECT?

Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

Which of the following items is NOT included in current assets? a. Accounts receivable. b. Bonds. c. Inventory. d. Short-term, highly liquid, marketable securities. e. Cash.

B! Bonds are reported on Cash Flow Statement

You have the following data on three stocks: Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

B;A

Which of the following statements are TRUE? a. The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, and thus on the firm's assets. However, EPS is not affected by the manner in which those assets are financed. b. Potential agency problems can arise between managers and stockholders, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders. c. The financial manager's proper goal should be to attempt to maximize the firm's expected cash flows, since that will add the most to the individual shareholders' wealth. d. Large, publicly owned firms like IBM and GE are controlled by their management teams. Ownership is generally widely dispersed; hence managers have great freedom in how they run the firm. Managers may operate in stockholders' best interests, but they also may operate in their own personal best interests. As long as they stay within the law, there is no way to either force or motivate managers to act in the stockholders' best interests. e. The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected projected after-tax income over the relevant time horizon, generally the coming year.

B! Managers have objectives other than shareholder value maximization

Inflation, recession, and high interest rates are economic events that are best characterized as being

AMONG THE FACTORS that are responsible for market risk.

True

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well diversified portfolio.

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Adding more such stocks will reduce the portfolio's unsystematic, or DIVERSIFIABLE, risk.

(Quiz/Sub#1)The yield to maturity is the rate that equates the price of the bond with the discounted cash flows. Incorrect Response the expected rate to be earned if held to maturity. the rate that is used to determine the market price of the bond. equal to the current yield for bonds priced at par. Correct Answer All of the above.

All answers are correct. Thus, the best answer is "All of the above." This answer is correct. However, so are all of the other choices. Thus, the best answer is "All of the above."

Which of the following statements is most correct?;

All else equal, if a bond's yield to maturity increases, its price will fall.

Which of the following statements is most correct?q

All else equal, long-term bonds have more interest rate risk than short term bonds. b. All else equal, higher coupon bonds have more reinvestment risk than low coupon bonds. c. All else equal, short-term bonds have more reinvestment risk than do long-term bonds. d. All of the statements above are correct.

One of the causes of the global financial crisis was:

All of the above were reasons for the global financial crisis.

With which of the following statements would most people in business agree? a. Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees. b. "Whistle blowers," because of the courage it takes to blow the whistle, are generally promoted more rapidly than other employees. c. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior. d. A corporation's short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation. e. Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

"Assume a project has normal cash flows (i.e., initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct?"

"All else equal, a project's NPV increases as the required rate of return declines"

You have recently accepted a one-year employment term by a firm. The firm has given you the option of receiving your salary as a lump sum value of $30,000 at the end of the year or as 12 monthly payments of $2,400 starting one month after you start work. If your relevant discount rate is 2 percent per month, then which salary options would you prefer? (Ignore taxes, risk, and consumption needs.) Choose the best answer

"Monthly payments, since it has the larger present value"

The importance of capital budgeting decisions is due to all of the following factors except for:

"capital budgeting techniques overcome the problems with error in forecasts for asset requirements and projected sales, we will still be able to determine if we should fund the project."

All of the following factors can complicate the post-audit process except

"the most successful firms, on average, are the ones that put the least emphasis on the post-audit"

(Quiz/Sub#1)An 8 percent annual coupon, noncallable bond has ten years until it matures and a yield to maturity of 9.1 percent. What should be the price of a 10-year noncallable bond of equal risk which pays an 8 percent semiannual coupon? Assume both bonds have a par value of $1,000. $ 898.64 $ 736.86 $ 854.27 $ 941.09 $ 964.23

$ 941.09 Feedback: The 8% annual coupon bond's YTM is 9.1%. The effective annual rate (EAR) is 9.1% because the bond is an annual bond. Now, we need to find the nominal rate for the semiannual bond which has the same EAR, so we can calculate its price.EFF% = 9.1P/YR = 2Solve for NOM% = 8.9019%.An equally risky 8% semiannual coupon bond has the same EAR.Now, solve for the semiannual bond's price. N = 2 ´ 10 = 20, I/YR = 8.9019/2 = 4.4510, PMT = 80/2 = 40, FV = 1,000, and solve for PV = $941.09.

(Quiz/Sub#2)You are considering investing in a security that matures in 10 years with a par value of $1,000. During the first five years, the security has an 8 percent coupon with quarterly payments (i.e., you receive $20 a quarter for the first 20 quarters). During the remaining five years the security has a 10 percent coupon with quarterly payments (i.e., you receive $25 a quarter for the second 20 quarters). After 10 years (40 quarters) you receive the par value. Another 10-year bond has an 8 percent semiannual coupon (i.e., the coupon payment is $40 every six months). This bond is selling at its par value, $1,000. This bond has the same risk as the security you are thinking of purchasing. Given this information, what should be the price of the security you are considering purchasing? $ 898.65 $1,060.72 $1,037.61 $ 943.22 $1,145.89

$1,060.72 Feedback: This was a difficult question. Since the securities are of equal risk, they must have the same effective rate. Since the comparable 10-year bond is selling at par, its nominal yield is 8 percent, the same as its coupon rate. Because it is a semiannual coupon bond, its effective rate is 8.16 percent. Using your calculator, enter NOM% = 8; P/YR = 2; and solve for EFF%. (Don't forget to change back to P/YR = 1.) So, since the bond you are considering purchasing has quarterly payments, its nominal rate is calculated as follows: EFF% = 8.16; P/YR = 4; and solve for NOM%. NOM% = 7.9216%. To determine the bond's price you must use the cash flow register because the payment amount changes. CF0 = 0, CF1 = 20; Nj = 20; CF2 = 25; Nj = 19; CF3 = 1025; I = 7.9216/4 = 1.9804; solve for NPV. NPV = $1,060.72.

(Quiz/Sub#2)One year ago Lerner and Luckmann Co. issued 15-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 14 years to maturity? Incorrect Response $1,077.01 $1,104.62 $1,162.00 $1,191.79

$1,191.79 N=14 I=5.5 Find PV=-1191.79 PMT=7.5%*1000=75 FV=1000

(Quiz/Sub#2)A firm's balance sheet currently shows $10,000,000 book value in bonds. The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is the current market value of the firm's debt? $5,276,731 $5,412,032 $5,547,332 $7,706,000

$5,412,032 N=10*2=20 I=12%/2=6% Finding PV=-541.20 PMT=(4%*1000)/2=20 FV=1000 Then compute how many bonds the company has outstanding. Book value of debt = 10,000,000 Par value of single bond=1,000 Number of bonds=Book value/Par value =10,000,000/1,000 =10,000 Bonds Calculate market value Present value of single bond*number of bonds =541.20*10,000 =5,412,032

False

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

Which of the following statements is CORRECT?

An investor can eliminate virtually all DIVERSABLE RISK if he or she holds a very large, well-diversified portfolio of stocks

You observe the following information regarding Companies X and Y: ∙ Company X has a higher expected return than Company Y. ∙ Company X has a lower standard deviation of returns than Company Y. ∙ Company X has a higher beta than Company Y. Given this information, which of the following statements is CORRECT? a. Company X has a lower coefficient of variation than Company Y. b. Company X has less market risk than Company Y. c. Company X's returns will be negative when Y's returns are positive. d. Company X's stock is a better buy than Company Y's stock. e. Company X has more diversifiable risk than Company Y.

a. Company X has a lower coefficient of variation than Company Y.

Which of the following statements is CORRECT? a. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. b. Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. c. You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks. d. If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. e. Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.

a. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.

Charlie and Lucinda each have $50,000 invested in stock portfolios. Charlie's has a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Lucinda's has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Charlie's and Lucinda's portfolios is zero. If Charlie and Lucinda marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio? a. The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. b. The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. c. The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. d. The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%. e. The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.

a. The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.

. Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. Your portfolio consists of 50% A and 50% B. Which of the following statements is CORRECT? a. The portfolio's expected return is 15%. b. The portfolio's standard deviation is greater than 20%. c. The portfolio's beta is greater than 1.2. d. The portfolio's standard deviation is 20%. e. The portfolio's beta is less than 1.2.

a. The portfolio's expected return is 15%.

Which of the following statements is CORRECT? a. If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. b. An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. c. There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. d. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. e. If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.

d. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

Which of the following statements is CORRECT? a. Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities. b. The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically. c. If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm. d. During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future. e. If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.

d. During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

Which of the following statements is CORRECT? a. The slope of the Security Market Line is beta. b. Any stock with a negative beta must in theory have a negative required rate of return, provided rRF is positive. c. If a stock's beta doubles, its required rate of return must also double. d. If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative. e. If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium.

d. If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.

Big Time 1.8

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