Principles of Finance Questions

Other things held constant, the higher a firm’s target payout ratio, the higher its expected growth rate should be.a. trueb. false b. false
Miller and Modigliani’s dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on either its cost of capital or its stock price.a. trueb, false a. true
If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a low payout ratio.a. trueb. false a. true
A “reverse split” reduces the number of shares outstanding.a. true b. false a. true
The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, if the tax rate on dividends is high relative to that on capital gains, then individuals with low taxable incomes should favor stocks with low payouts and high-income individuals should favor high-payout companies.a. trueb. false b. false
If a retired individual lives on his or her investment income, then it would make sense for this person to prefer stocks with high payouts so he or she could receive cash without going to the trouble and expense of selling stocks. On the other hand, it would make sense for an individual who would just reinvest any dividends received to prefer a low-payout company because that would save him or her taxes and brokerage costs.a. trueb. false a. true
Some investors prefer dividends to retained earnings (and the capital gains retained earnings bring), while others prefer retained earnings to dividends. Other things held constant, it makes sense for a company to establish its dividend policy and stick to it, and then it will attract a clientele of investors who like that policy.a. trueb. false a. true
If the information content, or signaling, hypothesis is correct, then a change in a firm’s dividend policy can have an important effect on its stock price and cost of equity.a. trueb. false a. true
If a firm uses the residual dividend model to set dividend policy, then dividends are determined as a residual after providing for the equity required to fund the capital budget. Under this model, the better the firm’s investment opportunities, the lower its payout ratio will be, other things held constant.a. true b. false a. true
If on January 3, 2011, a company declares a dividend of $1.50 per share, payable on January 31, 2011, to holders of record on January 19, then the price of the stock should drop by approximately $1.50 on January 17, which is the ex-dividend date.a. true b. false a. true
An increase in a firm’s expected growth rate would cause its required rate of return to a. increase. b. fluctuate less than before. c. possibly increase, possibly decrease, or possibly remain constant. d. decrease. e. fluctuate more than before. c. possibly increase, possibly decrease, or possibly remain constant.
Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT? a. All common stocks fall into one of three classes: A, B, and C. b. All common stocks, regardless of class, must have the same voting rights. c. All firms have several classes of common stock. d. All common stock, regardless of class, must pay the same dividend. e. Some class or classes of common stock are entitled to more votes per share than other classes. e. Some class or classes of common stock are entitled to more votes per share than other classes.
Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A BRequired return 10% 12%Market price $25 $40Expected growth 7% 9% a. These two stocks must have the same expected capital gains yield. b. These two stocks must have the same expected year-end dividend. c. These two stocks should have the same expected return. d. These two stocks should have the same price. e. These two stocks must have the same dividend yield. e. These two stocks must have the same dividend yield.
Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT? a. Stock B must have a higher dividend yield than Stock A. b. Stock A must have a higher dividend yield than Stock B. c. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B’s. d. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B’s. e. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B. d. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B’s.
If a stock’s dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium. a. The price of the stock is expected to decline in the future. b. The expected return on the stock is 5% a year. c. The stock’s required return must be equal to or less than 5%. d. The stock’s price one year from now is expected to be 5% above the current price. e. The stock’s dividend yield is 5%. d. The stock’s price one year from now is expected to be 5% above the current price.
Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? X YPrice $30 $30Expected growth (constant) 6% 4%Required return 12% 10% a. Stock Y has a higher dividend yield than Stock X. b. Stock X has the higher expected year-end dividend. c. One year from now, Stock X’s price is expected to be higher than Stock Y’s price. d. Stock X has a higher dividend yield than Stock Y. e. Stock Y has a higher capital gains yield. c. One year from now, Stock X’s price is expected to be higher than Stock Y’s price.
The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT? a. The stock price is expected to be $54 a share one year from now. b. The stock price is expected to be $57 a share one year from now. c. The stock’s dividend yield is 7%. d. The stock’s dividend yield is 8%. e. The current dividend per share is $4.00. a. The stock price is expected to be $54 a share one year from now.
A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock’s current price? a. $19.22 b. $18.75 c. $17.39 d. $18.29 e. $17.84 d. $18.29
If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $26.00, what is the stock’s expected dividend yield for the coming year? a. 4.57% b. 4.12% c. 4.34% d. 5.05% e. 4.81% e. 4.81%
If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock’s expected total return for the coming year? a. 8.81% b. 8.37% c. 8.59% d. 9.27% e. 9.03% d. 9.27%
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. a. True b. False b. 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. a. True b. false b. 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. a. True b. False b. 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. a. True b. False b. false
A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions. a. True b. False a. true
The slope of the SML is determined by the value of beta. a. True b. False b. false
The slope of the SML is determined by investors’ aversion to risk. The greater the average investor’s risk aversion, the steeper the SML. a. True b. False a. 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. a. True b. False a. 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. a. True b. False a. 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. a. True b. False a. 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. a. True b. False a. true
Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse. a. True b. False a. true
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. a. True b. False b. false
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. a. True b. False a. 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. a. True b. False a. true
“Risk aversion” implies that investors require higher expected returns on riskier than on less risky securities. a. True b. False a. 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. a. True b. False a. 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. a. True b. False a. true
Portfolio A has but 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. a. True b. False b. false
Diversification will normally reduce the riskiness of a portfolio of stocks. a. True b. False a. true
Which of the following events would make it more likely that a company would call its outstanding callable bonds? a. Market interest rates decline sharply. b. Inflation increases significantly. c. Market interest rates rise sharply. d. The company’s bonds are downgraded. e. The company’s financial situation deteriorates significantly. a.
Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows:T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%The differences in rates among these issues were most probably caused primarily by: a. Real risk-free rate differences. b. Maturity risk differences. c. Tax effects. d. Inflation differences. e. Default and liquidity risk differences e.
Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par? a. The rating agencies change the bond’s rating from Baa to Aaa. b. Adding additional restrictive covenants that limit management’s actions. c. Adding a call provision. d. Adding a sinking fund. e. Making the bond a first mortgage bond rather than a debenture. c.
A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT? a. The bond’s current yield is above 9%. b. If the bond’s yield to maturity declines, the bond will sell at a discount. c. The bond’s yield to maturity is above 9%. d. The bond’s expected capital gains yield is zero. e. The bond’s current yield is less than its expected capital gains yield. d.
Which of the following statements is CORRECT? a. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par. b. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par. c. All else equal, if a bond’s yield to maturity increases, its current yield will fall. d. All else equal, if a bond’s yield to maturity increases, its price will fall. e. A zero coupon bond’s current yield is equal to its yield to maturity. d.
A 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. If the yield to maturity stays constant until the bond matures, the bond’s price will remain at $850. c. The bond’s coupon rate exceeds its current yield. d. The bond’s current yield is equal to its coupon rate. e. The bond’s current yield exceeds its yield to maturity. a.
A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT? a. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. b. One bond’s price would increase, while the other bond’s price would decrease. c. The prices of both bonds will decrease by the same amount. d. The prices of the two bonds would remain constant. e. The prices of both bonds would increase by the same amount. a.
Which of the following statements is CORRECT? a. If a coupon bond is selling at par, its current yield equals its yield to maturity. b. If a coupon bond is selling at a premium, its current yield equals its yield to maturity. c. If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity. d. If a bond’s yield to maturity exceeds its annual coupon, then the bond will trade at a premium. e. If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond. a.
Morin Company’s bonds mature in 8 years, have a par value of $1,000, and make an annual coupon interest payment of $65. The market requires an interest rate of 8.2% on these bonds. What is the bond’s price? a. $925.62 b. $972.48 c. $948.76 d. $996.79 e. $903.04 e.
Malko Enterprises’ bonds currently sell for $1,050. They have a 6-year maturity, an annual coupon of $75, and a par value of $1,000. What is their current yield? a. 7.88% b. 8.27% c. 8.68% d. 7.14% e. 7.50% d.
Jose now has $500. How much would he have after 6 years if he leaves it invested at 5.5% with annual compounding? a. $622.20 b. $654.95 c. $591.09 d. $689.42 e. $723.89 D
How much would $1, growing at 3.5% per year, be worth after 75 years? a. $13.20 b. $15.28 c. $14.55 d. $13.86 e. $12.54 A
Suppose a State of California bond will pay $1,000 eight years from now. If the going interest rate on these 8-year bonds is 5.5%, how much is the bond worth today? a. $792.02 b. $684.18 c. $754.31 d. $718.39 e. $651.60 E
Suppose the U.S. Treasury offers to sell you a bond for $747.25. No payments will be made until the bond matures 5 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond at the offer price? a. 4.86% b. 6.00% c. 6.60% d. 4.37% e. 5.40% B
Bob has $2,500 invested in a bank that pays 4% annually. How long will it take for his funds to double? a. 15.15 b. 16.79 c. 17.67 d. 15.95 e. 14.39 C
You want to go to Europe 5 years from now, and you can save $3,100 per year, beginning one year from today. You plan to deposit the funds in a mutual fund that you think will return 8.5% per year. Under these conditions, how much would you have just after you make the 5th deposit, 5 years from now? a. $21,264 b. $18,369 c. $20,251 d. $19,287 e. $22,327 B
What’s the rate of return you would earn if you paid $950 for a perpetuity that pays $85 per year? a. 8.95% b. 9.86% c. 10.88% d. 9.39% e. 10.36% A
What is the present value of the following cash flow stream at a rate of 6.25%?Years: 0 1 2 3 4 CFs: $0 $75 $225 $0 $300 a. $480.03 b. $433.23 c. $505.30 d. $411.57 e. $456.03 C
What’s the future value of $1,500 after 5 years if the appropriate interest rate is 6%, compounded semiannually? a. $2,016 b. $1,915 c. $1,819 d. $2,117 e. $2,223 A
Which of the following statements is CORRECT? a. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. b. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity. c. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods. d. The cash flows for an annuity due must all occur at the beginning of the periods. e. The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month. D
If a firm raises capital by selling new bonds, it could be called the “issuing firm,” and the coupon rate is generally set equal to the required rate on bonds of equal risk. a. True b. False A
A call provision gives bondholders the right to demand, or “call for,” repayment of a bond. Typically, companies call bonds if interest rates rise and do not call them if interest rates decline.a. trueb. false B
A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation. a. True b. False B
The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present. a. True b. False A
The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond’s remaining maturity. a. True b. False A
Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond. a. True b. False B
As a general rule, a company’s debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured. a. True b. False A
Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength. a. True b. False A
There is an inverse relationship between bonds’ quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower. a. True b. False A
A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%. a. True b. False A
Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant? a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping. b. The expectations theory cannot hold if inflation is decreasing. c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping. d. If inflation is expected to decline, there can be no maturity risk premium. e. If the pure expectations theory holds, the corporate yield curve must be downward sloping. A
Which of the following factors would be most likely to lead to an increase in nominal interest rates? a. A new technology like the Internet has just been introduced, and it increases investment opportunities. b. The economy falls into a recession. c. Households reduce their consumption and increase their savings. d. There is a decrease in expected inflation. e. The Federal Reserve decides to try to stimulate the economy. A
Which of the following would be most likely to lead to a higher level of interest rates in the economy? a. Corporations step up their expansion plans and thus increase their demand for capital. b. The Federal Reserve decides to try to stimulate the economy. c. The economy moves from a boom to a recession. d. Households start saving a larger percentage of their income. e. The level of inflation begins to decline A
A bond trader observes the following information:-The Treasury yield curve is downward sloping.-Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds.-Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields.On the basis of this information, which of the following statements is most CORRECT? a. A 5-year corporate bond must have a higher yield than a 10-year Treasury bond. b. Since the Treasury yield curve is downward sloping, the corporate yield curve must also be downward sloping. c. A 10-year corporate bond must have a higher yield than a 5-year Treasury bond. d. The corporate yield curve must be flat. e. A 10-year Treasury bond must have a higher yield than a 10-year corporate bond. A
Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that a. Inflation is expected to decline in the future. b. Long-term bonds are a better buy than short-term bonds. c. Long-term interest rates are more volatile than short-term rates. d. The economy is not in a recession. e. Maturity risk premiums could help to explain the yield curve’s upward slope. E
Assume that interest rates on 20-year Treasury and corporate bonds are as follows:T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%The differences in these rates were probably caused primarily by: a. Tax effects. b. Maturity risk differences. c. Real risk-free rate differences. d. Default and liquidity risk differences. e. Inflation differences. D
Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT? a. The maturity risk premium is assumed to be zero. b. In equilibrium, long-term rates must be equal to short-term rates. c. Inflation is expected to be zero. d. Consumer prices as measured by an index of inflation are expected to rise at a constant rate. e. An upward-sloping yield curve implies that future short-term rates are expected to decline. A
Which of the following statements is CORRECT? a. The real risk-free rate is higher for corporate than for Treasury bonds. b. The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates. c. Most evidence suggests that the maturity risk premium is zero. d. Liquidity premiums are higher for Treasury than for corporate bonds. e. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. B
Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 5.70% b. 5.14% c. 6.28% d. 5.42% e. 5.99% A
Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 6.75%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds? a. 1.08% b. 1.32% c. 1.45% d. 1.60% e. 1.20% E
You are considering investing in one of the these three stocks: StockStandard Deviation BetaA 20% 0.59B 10% 0.61C 12% 1.29If 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
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?YearsMarketStock AStock B10.030.160.0520.050.200.0530.010.180.0540.100.250.0550.060.140.05a. bA > +1; bB = 0.b. bA = 0; bB = 1.c. bA < 0; bB = 0.d. bA 0; bB = 1 bA < 0; bB=0 C
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
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
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
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. E
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
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
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
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
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
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
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 C
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= r.d. All of the above statements must hold for equilibrium to exist; that is^R= r =-R.e.None of the above statements is correct. D
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
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. 12%
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? 5.8%
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? [(1.12×20)-.9+1.2]/20 = 1.165
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.) 3.374.25% + .7(11%-4.25%) = 8.984.25%+1.2(11%-4.25%) = 12.3512.35-8.98= 3.37

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