Test 2 - assessments 7-12

a probability distribution is

A) a summary of the different values that random variable can take, along with their relative likelihoods

which of these statements is true:

A) an empirical return distribution is more useful to describe the past, which a theoretical return distribution is more useful to predict the future

an efficient portfolio is one which

A) has no diversifiable risk D) can have reduced variance only by accepting lower accepted return

Firms with the highest equity beta have A) high operating leverage and high financial leverage B) low operating leverage and low financial leverage C) high operating leverage and low financial leverage D) low operating leverage and high financial leverage

A) high operating leverage and high financial leverage

Which of the following is true? A) idiosyncratic risk is less important for diversified investors than market risk B) both idiosyncratic risk and market risk are equally relevant for diversified investors C) idiosyncratic risk is more important for diversified investors than market risk D) market risk is always relevant for diversified investors, but idiosyncratic risk is relevant for diversified short-term horizons

A) idiosyncratic risk is less important for diversified investors than market risk

Yield curves are normally A) upward sloping B) downward sloping C) flat

A) upward sloping

What are the important disadvantages of debt, in practice?

A,B The greater the leverage of the firm, the greater the likelihood of bankruptcy and incu AND Debt generates agency costs, such as the tendency of firms to take on excessive risk

A premium bond is a bond A) whose issue price is greater than its face value B) whose credit rating is high C) whose yield to maturity is lower than its coupon rate D) whose risk is higher than the average bond

A,C A) whose issue price is greater than its face value C) whose yield to maturity is lower than its coupon rate

If corporate and personal taxes exist, and interest payments are tax deductible for corporations, would firms take on as much debt as possible?

A,C No. The effective personal tax rate on equity is usually lower than the effective personal tax rate.... AND No. Even though interest payments are tax-deductible to the corporation.....

Bankruptcy is bad for the following reasons

A,C,D In bankruptcy, claims are often restructured and the new claims have to be valued, which involves negotiating costs. This reduce firm value AND Illiquid assets often have to be sold off in a rush at lower than intrinsic value. This reduces firm value AND In bankruptcy, asset either have to be sold off, generating transaction costs. Those that are not sold and this generates negotiating costs. this reduces firm value

An asset's beta A) A measure of an asset's exposure to system-wide risk B) proportional to the asset's return variance C) is a measure of how the asset's price movements in the past relate to overall market movement D) is the covariance between the return on the asset and the return on the market portfolio di on the market portfolio E) the ratio of the asset's return variance of the market portfolio

A,D A) A measure of an asset's exposure to system-wide risk D) is the covariance between the return on the asset and the return on the market portfolio di on the market portfolio

Firms in the following sectors tend to have high betas A) services B) clothing C) restaurants D) technology

A,D services and technology

The MM hypothesis assumes that there are no

All of the above (information asymmetry, transaction costs, taxes, bankruptcy costs)

The CAPM is

B) a model that predicts the expected return for an asset C) a model that says only market-related or systematic risk is relevant for an asset's price F) an equilibrium model

the following firms are likely to have high asset betas

B) firms with niche appeal D) firms that sell luxury goods

market-wide risk is more relevant for asset pricing than idiosyncratic-risk because

B) investors generally hold diversified portfolios

the crucial assumption that allows insurance to work is that

B) shocks are relatively uncorrelated across people

Issuing equity is bad for existing shareholders because it dilutes earnings. SUppose the number of shares outstnding is 100k, and earning per share is currently $2. 100k new shares are issued at a price of $20/per share raising new equity of $2000k, which are invested in a project expected to yield annual earnings of $150k. New EPS...........

C and D Can't tell; need more existing information on whether the new project is of higher or lower risk than the existing projects or of equal risk AND Can't tell; we need to know whether the stock market is overvaluing or undervaluing the stock

An asset with a beta less than 1 A) is a good investment B) is a good ivnestment C) is less risky than the market portfolio D) how lower return variance than the market portfolio

C) is less risky than the market portfolio

A theoretical probability distribution can be described using more parameters than an empirical frequency distribution

False

A yield curve plots the yields on bonds over time (T/F)

False

As the bond yield increases, the bond becomes more valuable to the investor and, therefore, the price increases (T/F)

False

Coupons on US bonds are usually paid out once a year (T/F)

False

Long-term bond prices are less volatile than short-term bond prices (T/F)

False

Premium bond prices tend to increase over time (T/F)

False

The coupon rate on a bond measure's the investor's return on their investment (T/F)

False

The following is idiosyncratic risk: the risk that the Fed will increase interest rates, thus decreasing demand for real estate company X's products

False

The holding period return is just another name for the bond yield - they both measure the return to the investment (T/F)

False

The quoted price of a coupon bond is what the buyer pays for it (T/F)

False

The standard error of the estimate of the expected return is higher than the standard deviation of return

False

Zero-coupon bonds sometimes sell for more than their face value (t/f)

False

The NY times in its recent report on the sale of Starwood hotels reported "we do not believe Marriott is willing to incur earnings......"....

Managers are evaluated and compensated on earnings per share, this is why they worry about earnings dilution even though it is unrelated to market value per se

If bankruptcy was costless and there was no information asymmetry, but interest payments are tax-deductible, what is the average cost of capital

The WACC is the weighted average of the cost of equity and the after-tax cost of debt

Long-term bond yields are less volatile than short-term bond yields (T/F)

True

The Yield to Maturity on US bonds is usually expressed as an Annualized Percentage Rate (T/F)

True

The following is idiosyncratic risk: the risk that the new firm x's employees will be hired away by competitors

True

The following is idiosyncratic risk: the risk that the new product firm x's manager expects his r&d division to produce will not materialize

True

the WACC is computed as the weighted average of the cost of equity an the cost of debt. What would you use to compute the cost of equity

a combination of all three (CAPM, gordon growth, average return on firms equity over last 5 yrs)

the efficient markets hypothesis says that an asset's current price reflects

all available information

The WACC is used to discount project cashflows because

all of the above (it is the rate of return required by investors on projects of similar risk in the market place, it is the firms cost of fuds, any projects not earning this rate will reduce the value of the firm)

If transaction costs are zero, there is no information asymmetry or personal taxes and bankruptcy is costless and interest payments are tax-deductible, what is the optimal amount of debt to have

as much debt as possible

According to the MM hypothesis, choosing the right capital structure can increase the value of the firm

false

According to the MM hypothesis, if a firm does an equity-for-debt swap, but does not change the operations of the firm, the value of the firm's equity will not change

false

Bondholders do not have to worry about opportunistic managerial actions because they can always use bond covenants to specify what a manager can or cannot do

false

Empirically, it is true that stock prices incorporate privately held information even before they become public

false

For the EMH to be true, all investors should have enough wealth to buy and sell stocks

false

For the EMH to be true, all investors would need to be sophisticated

false

If the MM hypothesis holds, the firm's cost of capital depends on how close is to the firm's optimal leverage

false

If the MM hypothesis holds, the risk of equity does not change as we increase the leverage of the firm

false

Leverage should have no impact on human resource management

false

Managers acting on excessive dividends when a firm is in trouble because the firm needs to keep all the financial resources it has

false

Stock Market investors should read online or text publications to find out which stocks are overprices and which are underpriced. This will allow them to increase the value of their portfolio

false

The Efficient Markets Hypothesis says that the financial markets are efficient - they have minimal operational costs of running the market

false

The following is idiosyncratic risk: the risk that the economy slows, decreasing demand for firm x's products

false

There is a lot of cross-sectional variation in debt-equity ratios but they do not vary systematically across....

false

Under MM, the value of the firm is independent of its capital structure, but the weighted average cost of capital still depends on the capital structure

false

a theoretical probability distribution can be described using more parameters than an empirical frequency distribution

false

according to the CAPM, the risk premium for a security with high diversifiable risk and high systematic risk is greater than the risk premium for a security with low diversifiable risk and high systematic risk

false

an investor should not concern herself with firm-specific uncertainty even if she holds only equity of one particular firm

false

if changes in prices are unpredictable, that is evidence against the EMH

false

in practice, analyzing fundamental information about a stock from its financial statements or elsewhere is pointless because prices have already incorporated that information

false

insurance policies are useful primarily because they transfer risk from one party to another

false

standard deviation is a good measure of risk for somebody who is primarily worried about loss of capital

false

the geometric mean is greater than the arithmetic mean

false

the risk premium for every asset is positive

false

Your friend makes the following argument: If there are no transaction costs, taxes or information asymmetry, as we increase the leverage of the firm ,the risk of equity will increase. consequently......

false, as the leverage increases, the weight on the cost of debt, which is smaller, increases to keep the cost of capital constant

Issuing equity is bad for existing shareholders because it diluted earnings. New shareholders have claims to the firm's earnings, so existing shareholders are worse off. As a result, stock prices drop. Is this true or false?

false; if new equity is issued, the firm has access to fresh resources, which can be invested to increase. So if earnings are increased and the number of shareholders is also increased, the net impact on earning per share is ambiguous

a firm believes that demand and supply conditions are likely to remain the same for the next five years, so that the number of units sold will remain constant. it also expects inflation to be 5% a year for the next five year. sales for the year just ended were $1m

forecasted revenues will rise to $1.05 next year and will increase at 5% per year for the next 4 years

which of the following is true?

idiosyncratic risk is less important for diversified investors than market risk

market-wide risk is more relevant for asset pricing than idiosyncratic-risk because

investors generally hold diversified portfolios

the variance of asset returns is measured in the following units

percent-squared

Suppose we had created portfolios of investment in different asset categories in 1925, with an initial investment of $100.......

portfolio of small US stocks, portfolio of large US stocks, portfolio of US corporate bonds, one-month treasury bills

the WACC computation requires you to use the weighted average of the after-tax cost of debt and the cost of eq.....firm balance sheet shows $30m of debt and $70 of equity.....

sean disagrees with john and frank and believes you should use 20:80 because that is the appropriate financing proportion for the current project; he thinks the firms current financing practice is irrelevant

The WACC is computed as the weighted average of the cost of equity and the cost of debt. The form does not have any recently issued bonds. Which of the following statements is correct

the cost of debt is the yield on corporate bonds with the same bond rating as the firm's debt

the WACC is computed as the weighted average of the cost of equity and the cost of debt. which of these statements is correct? the cost of debt is:

the coupon rate on the firms' recently issued bond, if the bond was issued at par

the discount rate to be used for discount cashflows from a project is

the weighted average cost of capital

Your project manager has forecast savings from a proposed investment to most likely be $10m a year for the next 10 years. however, he believes that there is a 10% chance that it will be $`12m and a 10% chance is will be $8m. you run the numbers and discover the NPV is negative using 8mil for savings......

the weighted average of the npvs for the 3 cases is positive; hence we should accept the project

it is often useful to classify assets in different categories that vary in risk from a very safe class to a very risky class. which of the following is a common list of asset categories in order of increasing risk

treasury bills, corporate bonds, large stocks, small stocks

According to the EMH, when a firm announces a new capital budgeting project, the price of the firm's stock should increase

true

According to the MM hypothesis, if a firm does an equity-for-debt swap, but does not change the operations of the firm, the sum total of the firm's debt and equity will not change

true

According to the MM hypothesis, the value of the firm is determined by its operations, not by its financial structure

true

Firms selling durable goods are more affected by financial distress than firms selling nondurable goods

true

If there are no transaction costs or information asymmetry, but interest on debt is deductible by the firm, then the value of the firm will be increasing in the amount of debt used in financing the firm

true

The market risk premium is always positive

true

the following is idiosyncratic risk: the risk that the main production plant of company x is shut down due to a tornado

true

Suppose the EMH holds. Then, if the price of a given stock has been rising for over the past 5 days

we can't tell

which of the following is true

we should be interested in historical return data because return distributions are relatively stable across time

if we plot the volatilities of returns on individual stocks against their historical average returns, the resulting line would

zero slope