Final Exam

CHAPTER 24—BANKRUPTCY, REORGANIZATION, AND LIQUIDATION Total Cost = k(C/2) + c(T/C) TRUE/FALSE 1. A central question that must be addressed in bankruptcy proceedings is whether the firm’s inability to meet scheduled interest payments results from a temporary cash flow problem or from a potentially permanent problem caused by falling asset values. True 2. In the event of bankruptcy under the federal bankruptcy laws, debtholders have a prior claim to a firm’s income and assets before both common and preferred stockholders. Moreover, in a bankruptcy all debtholders are treated equally as a single class of claimants. False 3. The basic doctrine of fairness under bankruptcy provisions states that claims must be recognized in the order of their legal and contractual priority. True 4. The primary test of feasibility in a reorganization is whether the firm’s fixed charges after reorganization can be covered by its projected cash flows. True 5. Bankruptcy plays no role in settling labor disputes and product liability suits. Such issues are outside the bounds of bankruptcy law and are covered by other statutes. False 6. Bankruptcy laws have been used to help reach settlements in major product liability lawsuits. By using financial projections to show that contingent claims against the company jeopardize its existence, agreements are reached, partially satisfying claimants, and allowing the firm to continue operating. True 7. Even if a firm’s cash flow projections indicate that it will soon be unable to meet its interest payments, a bankruptcy case cannot begin until the firm actually defaults on a scheduled payment. False 8. One of the actions that can be taken in bankruptcy under the standard of feasibility is to replace existing management with a new team if the quality of management is judged to have been substandard. True MULTIPLE CHOICE 9. Chapter 7 of the Bankruptcy Act is designed to do which of the following? a. Establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments. b. Ensure that the firm is viable after emerging from bankruptcy. c. Allow the firm to negotiate with each creditor individually. d. Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt. e. Protect shareholders against creditors. 10. Which of the following statements is most CORRECT? a. Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws. b. All bankruptcy petitions are filed by creditors seeking to protect their claims against firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm’s management. c. Chapters 11 and 7 are the most important bankruptcy chapters for financial management purposes. If a reorganization plan cannot be worked out under Chapter 11, then the company will be liquidated as prescribed in Chapter 7 of the Act. d. “Restructuring” a firm’s debt can involve forgiving a certain portion of the debt, but it cannot call for changing the debt’s maturity or its contractual interest rate. e. Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time. 11. Which of the following statements is most CORRECT? Which of the following statements is most CORRECT? a. The primary test of feasibility in a reorganization is whether every claimant agrees with the reorganization plan. b. The basic doctrine of fairness states that all debtholders must be treated equally. c. Since the primary issue in bankruptcy is to determine the sharing of losses between owners and creditors, the “public interest” is not a relevant concern. d. While a firm is in bankruptcy, the existing management is always allowed to retain control, though the court will monitor its actions closely. e. To a large extent, the decision to dissolve a firm through liquidation versus keeping it alive through reorganization depends on a determination of the value of the firm if it is rehabilitated versus the value of its assets if they are sold off individually. 12. What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act? 1 is the highest claim, 5 is the lowest. (1) Trustees’ costs to administer and operate the firm. (2) Common stockholders. (3) General, or unsecured, creditors. (4) Secured creditors, who have a claim to the proceeds from the sale of specific property pledged to secure a loan. (5) Taxes due to federal and state governments. a. 5, 4, 1, 3, 2 b. 4, 1, 5, 3, 2 c. 5, 1, 4, 2, 3 d. 1, 5, 4, 3, 2 e. 1, 4, 3, 5, 2 CHAPTER 25—PORTFOLIO THEORY AND ASSET PRICING MODELS TRUE/FALSE 1. The slope of the SML is determined by the value of beta. False 2. If you plotted the returns of Selleck & 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 Selleck’s stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future. True 3. If the returns of two firms are negatively correlated, then one of them must have a negative beta. True 4. A stock with a beta equal to −1.0 has zero systematic (or market) risk. False 5. It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm are negative. True 6. In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data. True 7. 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 low standard deviation stock. True 8. The CAPM is a multi-period model which takes account of differences in securities’ maturities, and it can be used to determine the required rate of return for any given level of systematic risk. False 9. The SML relates required returns to firms’ systematic (or market) risk. The slope and intercept of this line can be influenced by managerial actions. False 10. The Y-axis intercept of the SML indicates the return on an individual asset when the realized return on an average (b = 1) stock is zero. False 11. We will almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security. False 12. Arbitrage pricing theory is based on the premise that more than one factor affects stock returns, and the factors are specified to be (1) market returns, (2) dividend yields, and (3) changes in inflation. False MULTIPLE CHOICE 13. You have the following data on three stocks: Stock Standard Deviation Beta A 0.15 0.79 B 0.25 0.61 C 0.20 1.29 As a 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; C. c. C; A. d. C; B. e. A; A. 14. Which is the best measure of risk for an asset held in isolation, and which is the best measure for an asset held in a diversified portfolio? a. Standard deviation; correlation coefficient. b. Beta; variance. c. Coefficient of variation; beta. d. Beta; beta. e. Variance; correlation coefficient. 15. Which of the following is NOT a potential problem with beta and its estimation? 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 than the “true” or “expected future” beta. b. The beta of “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. There is a wide confidence interval around a typical stock’s estimated beta. e. Sometimes a security or project does not have a past history which can be used as a basis for calculating beta. 16. Stock A’s beta is 1.5 and Stock B’s beta is 0.5. 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 Stock A. b. Stock A must be a more desirable addition to a portfolio than Stock B. c. The expected return on Stock A should be greater than that on Stock B. d. The expected return on Stock B should be greater than that on Stock A. e. When held in isolation, Stock A has greater risk than Stock B. 17. For markets to be in equilibrium (that is, for there to be no strong pressure for prices to depart from their current levels), 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 expected rate of return must be equal to the required rate of return; that is,  K^ = k. b. The required rate of return must equal the realized rate of return; that is, r = . c. All companies must pay dividends. d. No companies can be in danger of declaring bankruptcy. e. The expected rate of return must be equal to the required rate of return; that is, = r. 18. Which of the following statements is CORRECT? a. The slope of the CML is (M − rRF)/bM. b. All portfolios that lie on the CML to the right of M are inefficient. c. All portfolios that lie on the CML to the left of M are inefficient. d. The slope of the CML is (M − rRF)/M. e. The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio. 19. In a portfolio of three different stocks, which of the following could NOT be true? a. The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. b. The beta of the portfolio is less than the betas of each of the individual stocks. c. The beta of the portfolio is greater than the beta of one or two of the individual stocks’ betas. d. The beta of the portfolio cannot be equal to 1. e. The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. 20. 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 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. 21. Which of the following statements is CORRECT? a. The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6. b. The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94. c. The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about 0.94. d. The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6. e. The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3. 22. Which of the following statements is CORRECT? a. The characteristic line is the regression line that results from plotting the returns on a particular stock versus the returns on a stock from a different industry. b. The slope of the characteristic line is the stock’s standard deviation. c. The distance of the plot points from the characteristic line is a measure of the stock’s market risk. d. The distance of the plot points from the characteristic line is a measure of the stock’s diversifiable risk. e. “Characteristic line” is another name for the Security Market Line. 23. Which of the following statements is CORRECT? a. Richard Roll has argued that it is possible to test the CAPM to see if it is correct. b. Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the CAPM. c. Tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable. d. The most widely cited study of the validity of the CAPM is one performed by Modigliani and .......