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Which of the following portfolios have the least risk?
A) A portfolio of treasury bills
If held for possible resale, long-term government bonds have:
A) Interest rate risk
If the average annual rate of return for common stocks is 13%, and treasury bills is 3.8%, what is the average market risk premium?
C) 9.2%
Safro Corporation has had returns of -5%, 15% and 20% for the past three years. Calculate the standard deviation of the returns. (hint: assume this is a sample of the population).
D) 13.23%
The portion of the risk that can be eliminated by diversification is called:
A) Unique risk
Stock A has an expected return of 10% per year and stock B has an expected return of 20%. If 55% of the funds are invested in stock B, what is the expected return on the portfolio of stock A and stock B?
C) 15.5%
For a two-stock portfolio, the maximum reduction in risk occurs when the correlation coefficient between the two stocks is:
D) −1
The “beta” is a measure of:
B) Market risk
The variance or standard deviation is a measure of:
A) Total risk
The beta of a risk-free portfolio is:
A) 0
The variance of the market return is
C) The expected squared deviation from the expected
What is the arithmetic average return of bonds earning 5%, stocks earning 11% and treasuries earning 2%?
C) 6%
Diversification works because?
B) Correlation coefficients
Stocks with betas _______________ tend to amplify the overall movements of the market.
B) Greater than 1
The risk of a well diversified portfolio depends upon the
A) Market risk
CAP8
Investments A and B both offer an expected rate of return of 12%. If the standard deviation of A is 20% and that of B is 30%, then investors would:
A) Prefer A to B
When stocks with the same expected return are combined into a portfolio, the expected return of the portfolio is:
C) Equal to the average expected return of the stocks
Efficient portfolios are those that offer:
A) Highest expected return for a given level of risk
The beta of a Treasury bill portfolio is:
A) Zero
The security market line (SML) is the graph of:
C) Expected rate of return on investment vs. beta.
If the beta of Freon is 0.73, risk-free rate is 5.5% and the market rate of return is 13.5%, calculate the expected rate of return from Freon:
D) 11.3%
If a stock is overpriced it will plot:
C) Below the security market line
A “factor” in APT is a variable that:
A) Affects the return of risky assets in a systematic manne
The drawback of the CAPM is that it:
B) Requires a single measure of systematic risk
If returns are normally distributed, the only two measures that an investor should consider are:
C) Expected return and standard deviation
The expected rate of return of Stock (X), given a beta of 1.3, risk free rate of 6%, and a market risk premium of 7%, is:
D) 15.1%
What is the risk free rate given a beta of .8, a market risk premium of 6%, and an expected return of 9.8%?
B) 5.0%
The capital asset pricing model states that the expected market risk premium of each investment is proportional to its:
A) Beta
The risk premium for Treasury bills is always equal to:
C) Zero
The Three-Factor Model proposed by Fama and French suggests that expected returns can be determined by:
D) All of the above
CAP9
The term cost of capital for a project depends on:
A) The use to which the capital is put, i.e. the project
If a firm uses the same company cost of capital for evaluating all projects, which of the following is likely?
C) Both A and B
Using the company cost of capital to evaluate a project is:
C) Correct for projects that are about as risky as the average of the firm’s other assets
Which of the following types of projects is likely to have the lowest risk?
D) Cost improvement
The hurdle rate for capital budgeting decisions is:
A) The cost of capital
If you graph common stock returns on the Y axis and market returns on the X-axis, the slope of the regression line is:
B) Beta
A company has a cost of capital of 15%. However, it is introducing a new product that it considers to be a very risky endeavor. What can you say about the appropriate discount rate for the project?
C) The rate used should be greater than 15%
The market value of Charter Cruise Company’s equity is $15 million, and the market value of its risk-free debt is $5 million. If the required rate of return on the equity is 20% and that on the debt is 8%, calculate the company’s cost of capital. (Assume no taxes.)
A) 17%
A project has an expected risky cash flow of $1,000 in Year 1. The risk-free rate is 4%, the market rate of return is 12%, and the project’s beta is 1.5. Calculate the certainty equivalent cash flow for Year 1.
A) $896.55
A project has an expected cash flow of $300 in year 3. The risk-free rate is 5%, the market risk premium is 8% and the project’s beta is 1.25. Calculate the certainty equivalent cash flow for year 3.
A) $228.35
Which of the following type of projects has the highest risk?
D) Find the certainty-equivalent cash flow and discount it at the risk-free rate
A company cost of capital is quoted as 8%. The book value of debt and equity was used in the calculation. Which of the following adjustments to the calculation is most likely to cause an increase in the cost of capital?
B) Market value of equity is used
What is the cost of capital for a firm with market value of debt of $20 million and market value of equity of $60 million, given a cost of equity at 12% and a cost of debt at 6%? Assume no taxes.
C) 10.5%
What is the cost of capital for a firm with market value of debt of $10 million and market value of equity of $90 million, given a cost of equity at 10% and a cost of debt at 4%? Assume no taxes.
D) 9.4%