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FRl 301 Midterm 2 chp 13,14, & 16 (conceptual) Exam With
100% Verified Answers
You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent? A. arithmetic return B. historical return C. expected return D. geometric return E. required return - ANSWER C. expected return
- Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total. Which one of the following terms most applies to Suzie's investments? A. index B. portfolio C. collection D. grouping E. risk-free - ANSWER B. portfolio
Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which one of the following? A. portfolio return B. portfolio weight C. degree of risk D. price-earnings ratio
E. index value - ANSWER B. portfolio weight
Which one of the following is a risk that applies to most securities? A. unsystematic B. diversifiable C. systematic D. asset-specific E. total - ANSWER C. systematic
A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent? A. portfolio B. nondiversifiable C. market D. unsystematic E. total - ANSWER D. unsystematic
The principle of diversification tells us that:
A. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. B. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. C. spreading an investment across five diverse companies will not lower the total risk. D. spreading an investment across many diverse assets will eliminate all of the systematic risk. E. spreading an investment across many diverse assets will eliminate some of the total risk. - ANSWER E. spreading an investment across many diverse assets will eliminate some of the total risk.
C. beta coefficient D. risk-free interest rate E. market risk premium - ANSWER E. market risk premium
Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? A. capital asset pricing model B. time value of money equation C. unsystematic risk equation D. market performance equation E. expected risk formula - ANSWER A. capital asset pricing model
Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the: A. average arithmetic return. B. expected return. C. market rate of return. D. internal rate of return. E. cost of capital. - ANSWER E. cost of capital.
The expected return on a stock given various states of the economy is equal to the: A. highest expected return given any economic state. B. arithmetic average of the returns for each economic state. C. summation of the individual expected rates of return. D. weighted average of the returns for each economic state. E. return for the economic state with the highest probability of occurrence. - ANSWER D. weighted average of the returns for each economic state.
The expected return on a stock computed using economic probabilities is: A. guaranteed to equal the actual average return on the stock for the next five years. B. guaranteed to be the minimal rate of return on the stock over the next two years. C. guaranteed to equal the actual return for the immediate twelve month period. D. a mathematical expectation based on a weighted average and not an actual anticipated outcome. E. the actual return you should anticipate as long as the economic forecast remains constant. - ANSWER D. a mathematical expectation based on a weighted average and not an actual anticipated outcome.
The expected risk premium on a stock is equal to the expected return on the stock minus the: A. expected market rate of return. B. risk-free rate. C. inflation rate. D. standard deviation. E. variance. - ANSWER B. risk-free rate.
Standard deviation measures which type of risk? A. total B. nondiversifiable C. unsystematic D. systematic E. economic - ANSWER A. total
The expected rate of return on a stock portfolio is a weighted average where the weights are based on the: A. number of shares owned of each stock. B. market price per share of each stock.
B. II and IV only C. I and II only D. I, II, and III only E. I, II, III, and IV - ANSWER D. I, II, and III only
. If a stock portfolio is well diversified, then the portfolio variance: A. will equal the variance of the most volatile stock in the portfolio. B. may be less than the variance of the least risky stock in the portfolio. C. must be equal to or greater than the variance of the least risky stock in the portfolio. D. will be a weighted average of the variances of the individual securities in the portfolio. E. will be an arithmetic average of the variances of the individual securities in the portfolio. - ANSWER B. may be less than the variance of the least risky stock in the portfolio.
The standard deviation of a portfolio: A. is a weighted average of the standard deviations of the individual securities held in the portfolio. B. can never be less than the standard deviation of the most risky security in the portfolio. C. must be equal to or greater than the lowest standard deviation of any single security held in the portfolio. D. is an arithmetic average of the standard deviations of the individual securities which comprise the portfolio. E. can be less than the standard deviation of the least risky security in the portfolio. - ANSWER E. can be less than the standard deviation of the least risky security in the portfolio.
The standard deviation of a portfolio: A. is a measure of that portfolio's systematic risk. B. is a weighed average of the standard deviations of the individual securities held in
that portfolio. C. measures the amount of diversifiable risk inherent in the portfolio. D. serves as the basis for computing the appropriate risk premium for that portfolio. E. can be less than the weighted average of the standard deviations of the individual securities held in that portfolio. - ANSWER
Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights?
A. Given the unequal weights of both the securities and the economic states, the standard deviation of the portfolio must equal that of the overall market. B. The weights of the individual securities have no effect on the expected return of a portfolio when multiple states of the economy are involved. C. Changing the probabilities of occurrence for the various economic states will not affect the expected standard deviation of the portfolio. D. The standard deviation of the portfolio will be greater than the highest standard deviation of any single security in the portfolio given that the individual securities are well diversified. E. Given both the unequal weights of the securities and the economic states, an investor migh - ANSWER E. Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.
Which one of the following events would be included in the expected return on Sussex stock? A. The chief financial officer of Sussex unexpectedly resigned. B. The labor union representing Sussex' employees unexpectedly called a strike. C. This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated. D. The price of Sussex stock suddenly declined in value because researchers accidentally discovered that one of the firm's products can be toxic to household pets. E. The board of directors made an unprecedented decision to give sizeable bonuses to
A. reward to risk ratio. B. weighted capital gains rate. C. structured cost of capital. D. subjective cost of capital. E. weighted average cost of capital.
- ANSWER E. weighted average cost of capital.
When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach. A. subjective risk B. pure play C. divisional cost of capital D. capital adjustment E. security market line - ANSWER B. pure play
A firm's cost of capital: A. will decrease as the risk level of the firm increases. B. for a specific project is primarily dependent upon the source of the funds used for the project. C. is independent of the firm's capital structure. D. should be applied as the discount rate for any project considered by the firm. E. depends upon how the funds raised are going to be spent. - ANSWER E. depends upon how the funds raised are going to be spent.
The weighted average cost of capital for a wholesaler: A. is equivalent to the aftertax cost of the firm's liabilities. B. should be used as the required return when analyzing a potential acquisition of a retail outlet. C. is the return investors require on the total assets of the firm. D. remains constant when the debt-equity ratio changes. E. is unaffected by changes in corporate tax rates. - ANSWER C. is the return investors require on the total assets of the firm.
B. unaffected by changes in the market risk premium. C. highly dependent upon the growth rate and risk level of the firm. D. generally less than the firm's aftertax cost of debt. E. inversely related to changes in the firm's tax rate. - ANSWER C. highly dependent upon the growth rate and risk level of the firm.
The cost of equity for a firm: A. tends to remain static for firms with increasing levels of risk. B. increases as the unsystematic risk of the firm increases. C. ignores the firm's risks when that cost is based on the dividend growth model. D. equals the risk-free rate plus the market risk premium. E. equals the firm's pretax weighted average cost of capital. - ANSWER C. ignores the firm's risks when that cost is based on the dividend growth model.
The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? I. firms that have a 100 percent retention ratio II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend A. I and II only B. I and III only C. II and III only D. I, II, and III only E. II, III, and IV only - ANSWER E. II, III, and IV only
The dividend growth model: A. is only as reliable as the estimated rate of growth.
B. can only be used if historical dividend information is available. C. considers the risk that future dividends may vary from their estimated values. D. applies only when a firm is currently paying dividends. E. uses beta to measure the systematic risk of a firm. - ANSWER A. is only as reliable as the estimated rate of growth.
Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure. A. This model considers a firm's rate of growth. B. The model applies only to non-dividend paying firms. C. The model is dependent upon a reliable estimate of the market risk premium. D. The model generally produces the same cost of equity as the dividend growth model. E. This approach generally produces a cost of equity that equals the firm's overall cost of capital. - ANSWER C. The model is dependent upon a reliable estimate of the market risk premium.
Which of the following statements are correct? I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant. A. I and III only B. II and IV only C. III and IV only D. I, II, and III only E. II, III, and IV only - ANSWER E. II, III, and IV only
The pre-tax cost of debt: A. is based on the current yield to maturity of the firm's outstanding bonds.
- ANSWER D. return on a perpetuity.
The cost of preferred stock: A. is equal to the dividend yield. B. is equal to the yield to maturity. C. is highly dependent on the dividend growth rate. D. is independent of the stock's price. E. decreases when tax rates increase. - ANSWER A. is equal to the dividend yield.
The capital structure weights used in computing the weighted average cost of capital: A. are based on the book values of total debt and total equity. B. are based on the market value of the firm's debt and equity securities. C. are computed using the book value of the long-term debt and the book value of equity. D. remain constant over time unless the firm issues new securities. E. are restricted to the firm's debt and common stock. - ANSWER B. are based on the market value of the firm's debt and equity securities.
Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct? A. The aftertax cost of debt will be greater than the current yield-to-maturity on the firm's bonds. B. The firm's cost of preferred is most likely less than the firm's actual cost of debt. C. The firm's cost of equity is unaffected by a change in the firm's tax rate. D. The cost of equity can only be estimated using the SML approach. E. The firm's weighted average cost of capital will remain constant as long as the capital structure remains constant. - ANSWER C. The firm's cost of equity is unaffected by a change in the firm's tax rate.
The aftertax cost of debt: A. varies inversely to changes in market interest rates. B. will generally exceed the cost of equity if the relevant tax rate is zero. C. will generally equal the cost of preferred if the tax rate is zero. D. is unaffected by changes in the market rate of interest. E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases - ANSWER E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases
The weighted average cost of capital for a firm may be dependent upon the firm's: I. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio. A. I and III only B. II and IV only C. I, II, and IV only D. I, III, and IV only E. I, II, III, and IV - ANSWER E. I, II, III, and IV
The weighted average cost of capital for a firm is the: A. discount rate which the firm should apply to all of the projects it undertakes. B. rate of return a firm must earn on its existing assets to maintain the current value of its stock. C. coupon rate the firm should expect to pay on its next bond issue. D. minimum discount rate the firm should require on any new project. E. rate of return shareholders should expect to earn on their investment in this firm. - ANSWER B. rate of return a firm must earn on its existing assets to maintain the current
- ANSWER A. The WACC should decrease as the firm's debt-equity ratio increases. . Homemade leverage is: A. the incurrence of debt by a corporation in order to pay dividends to shareholders. B. the exclusive use of debt to fund a corporate expansion project. C. the borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage. D. best defined as an increase in a firm's debt-equity ratio. E. the term used to describe the capital structure of a levered firm. - ANSWER C. the borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage.
Which one of the following states that the value of a firm is unrelated to the firm's capital structure? A. Capital Asset Pricing Model B. M&M Proposition I C. M&M Proposition II D. Law of One Price E. Efficient Markets Hypothesis - ANSWER B. M&M Proposition I
Which one of the following states that a firm's cost of equity capital is directly and proportionally related to the firm's capital structure? A. Capital Asset Pricing Model B. M&M Proposition I C. M&M Proposition II D. Law of One Price E. Efficient Markets Hypothesis - ANSWER C. M&M Proposition II
Which one of the following is the equity risk that is most related to the daily operations of
a firm? A. market risk B. systematic risk C. extrinsic risk D. business risk E. financial risk - ANSWER D. business risk
Which one of the following is the equity risk related to a firm's capital structure policy? A. market B. systematic C. extrinsic D. business E. financial - ANSWER E. financial
Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000. Which of the following terms is used to describe this tax savings? A. interest tax shield B. interest credit C. financing shield D. current tax yield E. tax-loss interest - ANSWER A. interest tax shield
The unlevered cost of capital refers to the cost of capital for a(n): A. private entity. B. all-equity firm. C. governmental entity. D. private individual.
