FINA 5320 - Exam 3 Theoretical Questions EXAM
QUESTIONS AND VERIFIED ACCURATE SOLUTION
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The risk premium for an individual security is computed by:
A. multiplying the security's beta by the market risk premium.
B. multiplying the security's beta by the risk-free rate of return.
C. adding the risk-free rate to the security's expected return.
D. dividing the market risk premium by the quantity (1 + Beta).
E. dividing the market risk premium by the beta of the security. - ANSWER-A. multiplying the security's
beta by the market risk premium.
You are comparing Stock A to Stock B. Stock A will return 9 percent in a boom and 4 percent in a
recession. Stock B will return 15 percent in a boom and lose 6 percent in a recession. The probability of a
boom is 60 percent with a 40 percent chance of a recession. Given this information, which one of these
two stocks should you prefer and why?
A. Stock A; because it has a higher expected return and appears to be more risky than Stock B
B. Stock A; because it has a higher expected return and appears to be less risky than Stock B
C. Stock A; because it has a slightly lower expected return but appears to be significantly less risky than
Stock B
D. Stock B; because it has a higher expected return and appears to be just slightly more risky than Stock
A
E. Stock B; because it has a higher expected return and appears to be less risky than Stock A - ANSWER-
B. Stock A; because it has a higher expected return and appears to be less risky than Stock B
The market risk premium is computed by:
A. adding the risk-free rate of return to the inflation rate.
B. adding the risk-free rate of return to the market rate of return.
C. subtracting the risk-free rate of return from the inflation rate.
D. subtracting the risk-free rate of return from the market rate of return.
E. multiplying the risk-free rate of return by the market beta. - ANSWER-D. subtracting the risk-free rate
of return from the market rate of return.
,The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is
referred to as the:
A. market rate of return.
B. market risk premium.
C. systematic return.
D. total return.
E. real rate of return. - ANSWER-B. market risk premium.
Which one of the following statements is correct concerning the standard deviation of a portfolio?
A. The greater the diversification of a portfolio, the greater the standard deviation of that portfolio.
B. The standard deviation of a portfolio can often be lowered by changing the weights of the securities
in the portfolio.
C. Standard deviation is used to determine the amount of risk premium that should apply to a portfolio.
D. The standard deviation of a portfolio is equal to the geometric average standard deviation of the
individual securities held within that portfolio.
E. The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the
individual securities held within the portfolio. - ANSWER-B. The standard deviation of a portfolio can
often be lowered by changing the weights of the securities in the portfolio.
When computing the weighted average cost of capital, which of these are adjusted for taxes?
A. cost of equity
B. cost of preferred stock
C. both the cost of equity and the cost of preferred stock
D. the costs of all forms of financing
E. cost of debt - ANSWER-E. cost of debt
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. overall rate which the firm must earn on its existing assets to maintain its value.
,C. rate the firm should expect to pay on its next bond issue.
D. maximum rate which the firm should require on any projects it undertakes.
E. rate of return that the firm's preferred stockholders should expect to earn over the long term. -
ANSWER-B. overall rate which the firm must earn on its existing assets to maintain its value
Companies will generally have a:
A. low beta if their sales are directly related to the market cycle.
B. high beta if their sales are highly dependent on the market cycle.
C. high beta if sales are independent of the market cycle.
D. high beta if their sales are highly variable but unrelated to the market cycle
E. low beta is their sales are highly cyclical. - ANSWER-B. high beta if their sales are highly dependent on
the market cycle.
The beta of debt is commonly considered to be:
A. equal to the market beta.
B. one-half of the equity beta.
C. the same as the asset beta.
D. zero.
E. one. - ANSWER-B. one-half of the equity beta.
The beta of a firm is more likely to be high under which two conditions?
A. high cyclical business activity and low operating leverage
B. high cyclical business activity and high operating leverage
C. low cyclical business activity and low financial leverage
D. low cyclical business activity and low operating leverage
E. low financial leverage and low operating leverage - ANSWER-B. high cyclical business activity and high
operating leverage
A firm with high operating leverage has:
A. low fixed costs in its production process.
, B. high variable costs in its production process.
C. high fixed costs in its production process.
D. high costs per unit.
E. low costs per unit. - ANSWER-C. high fixed costs in its production process.
For a multi-product firm, if a project's level of risk differs from that of the overall firm, then the:
A. CAPM can no longer be used to estimate the cost of equity as beta no longer applies.
B. project should be discounted using the overall firm's beta.
C. project should be discounted using a beta commensurate with the project's risks.
D. project should be discounted at the market rate.
E. project should be discounted at the T-bill rate. - ANSWER-C. project should be discounted using a beta
commensurate with the project's risks.
MM Proposition I without taxes proposes that:
A. the value of an unlevered firm exceeds that of a levered firm.
B. there is one ideal capital structure for each firm.
C. leverage does not affect the value of the firm.
D. shareholder wealth is directly affected by the capital structure selected.
E. the value of a levered firm exceeds that of an unlevered firm. - ANSWER-C. leverage does not affect
the value of the firm.
The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:
A. MM Proposition I with no tax.
B. MM Proposition II with no tax.
C. MM Proposition I with tax.
D. MM Proposition II with tax.
E. both MM I with and without tax.. - ANSWER-A. MM Proposition I with no tax.
The proposition that the value of the firm is independent of its capital structure is called:
QUESTIONS AND VERIFIED ACCURATE SOLUTION
|GET IT 100% ACCURATE!!!
The risk premium for an individual security is computed by:
A. multiplying the security's beta by the market risk premium.
B. multiplying the security's beta by the risk-free rate of return.
C. adding the risk-free rate to the security's expected return.
D. dividing the market risk premium by the quantity (1 + Beta).
E. dividing the market risk premium by the beta of the security. - ANSWER-A. multiplying the security's
beta by the market risk premium.
You are comparing Stock A to Stock B. Stock A will return 9 percent in a boom and 4 percent in a
recession. Stock B will return 15 percent in a boom and lose 6 percent in a recession. The probability of a
boom is 60 percent with a 40 percent chance of a recession. Given this information, which one of these
two stocks should you prefer and why?
A. Stock A; because it has a higher expected return and appears to be more risky than Stock B
B. Stock A; because it has a higher expected return and appears to be less risky than Stock B
C. Stock A; because it has a slightly lower expected return but appears to be significantly less risky than
Stock B
D. Stock B; because it has a higher expected return and appears to be just slightly more risky than Stock
A
E. Stock B; because it has a higher expected return and appears to be less risky than Stock A - ANSWER-
B. Stock A; because it has a higher expected return and appears to be less risky than Stock B
The market risk premium is computed by:
A. adding the risk-free rate of return to the inflation rate.
B. adding the risk-free rate of return to the market rate of return.
C. subtracting the risk-free rate of return from the inflation rate.
D. subtracting the risk-free rate of return from the market rate of return.
E. multiplying the risk-free rate of return by the market beta. - ANSWER-D. subtracting the risk-free rate
of return from the market rate of return.
,The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is
referred to as the:
A. market rate of return.
B. market risk premium.
C. systematic return.
D. total return.
E. real rate of return. - ANSWER-B. market risk premium.
Which one of the following statements is correct concerning the standard deviation of a portfolio?
A. The greater the diversification of a portfolio, the greater the standard deviation of that portfolio.
B. The standard deviation of a portfolio can often be lowered by changing the weights of the securities
in the portfolio.
C. Standard deviation is used to determine the amount of risk premium that should apply to a portfolio.
D. The standard deviation of a portfolio is equal to the geometric average standard deviation of the
individual securities held within that portfolio.
E. The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the
individual securities held within the portfolio. - ANSWER-B. The standard deviation of a portfolio can
often be lowered by changing the weights of the securities in the portfolio.
When computing the weighted average cost of capital, which of these are adjusted for taxes?
A. cost of equity
B. cost of preferred stock
C. both the cost of equity and the cost of preferred stock
D. the costs of all forms of financing
E. cost of debt - ANSWER-E. cost of debt
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. overall rate which the firm must earn on its existing assets to maintain its value.
,C. rate the firm should expect to pay on its next bond issue.
D. maximum rate which the firm should require on any projects it undertakes.
E. rate of return that the firm's preferred stockholders should expect to earn over the long term. -
ANSWER-B. overall rate which the firm must earn on its existing assets to maintain its value
Companies will generally have a:
A. low beta if their sales are directly related to the market cycle.
B. high beta if their sales are highly dependent on the market cycle.
C. high beta if sales are independent of the market cycle.
D. high beta if their sales are highly variable but unrelated to the market cycle
E. low beta is their sales are highly cyclical. - ANSWER-B. high beta if their sales are highly dependent on
the market cycle.
The beta of debt is commonly considered to be:
A. equal to the market beta.
B. one-half of the equity beta.
C. the same as the asset beta.
D. zero.
E. one. - ANSWER-B. one-half of the equity beta.
The beta of a firm is more likely to be high under which two conditions?
A. high cyclical business activity and low operating leverage
B. high cyclical business activity and high operating leverage
C. low cyclical business activity and low financial leverage
D. low cyclical business activity and low operating leverage
E. low financial leverage and low operating leverage - ANSWER-B. high cyclical business activity and high
operating leverage
A firm with high operating leverage has:
A. low fixed costs in its production process.
, B. high variable costs in its production process.
C. high fixed costs in its production process.
D. high costs per unit.
E. low costs per unit. - ANSWER-C. high fixed costs in its production process.
For a multi-product firm, if a project's level of risk differs from that of the overall firm, then the:
A. CAPM can no longer be used to estimate the cost of equity as beta no longer applies.
B. project should be discounted using the overall firm's beta.
C. project should be discounted using a beta commensurate with the project's risks.
D. project should be discounted at the market rate.
E. project should be discounted at the T-bill rate. - ANSWER-C. project should be discounted using a beta
commensurate with the project's risks.
MM Proposition I without taxes proposes that:
A. the value of an unlevered firm exceeds that of a levered firm.
B. there is one ideal capital structure for each firm.
C. leverage does not affect the value of the firm.
D. shareholder wealth is directly affected by the capital structure selected.
E. the value of a levered firm exceeds that of an unlevered firm. - ANSWER-C. leverage does not affect
the value of the firm.
The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:
A. MM Proposition I with no tax.
B. MM Proposition II with no tax.
C. MM Proposition I with tax.
D. MM Proposition II with tax.
E. both MM I with and without tax.. - ANSWER-A. MM Proposition I with no tax.
The proposition that the value of the firm is independent of its capital structure is called:
