T04 - Risks & Cost of Capital

MANAGEMENT ADVISORY SERVICES INVESTMENT RISK 1 . Catherine & Co. has extra cash at the end o the !
ear and is ana"!#in$ the %est &a! to in'est the (nds. The co)*an! sho("d in'est in a *ro+ect on"! i A. The ex*ected ret(rn on the *ro+ect exceeds the ret(rn on in'est)ents o co)*ara%"e ris,. -. The ret(rn on in'est)ents o co)*ara%"e ris, exceeds the ex*ected ret(rn on the *ro+ect. C. The ex*ected ret(rn on the *ro+ect is e.(a" to the ret(rn on in'est)ents o co)*ara%"e ris,. G"ei) D. The ret(rn on in'est)ents o co)*ara%"e ris, e.(a"s the ex*ected ret(rn on the *ro+ect. Interest-rate Risk / . 0hich o the o""o&in$ are co)*onents o interest1rate ris,2 G"ei) A. 3(rchasin$1*o&er ris, and de a("t ris,. C. 3ort o"io ris, and rein'est)ent1rate ris,. -. 3rice ris, and )ar,et ris,. D. 3rice ris, and rein'est)ent1rate ris,. 4. 5on$1ter) $o'ern)ent %onds ha'e6 A. Interest rate ris, -. De a("t ris, C. Mar,et ris, D. None o the a%o'e />. As the n()%er o stoc,s in a *ort o"io is increased6 A. ;ni.(e ris, decreases and a**roaches to #ero -. Mar,et ris, decrease C. ;ni.(e ris, decreases and %eco)es e.(a" to )ar,et ris,
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In ca*ita" )ar,et ana"!sisA the nons!ste)atic ris, a. Is corre"ated &ith .(a"itati'e as*ects o the (nder"!in$ entit!. %. Is corre"ated &ith .(antitati'e as*ects o the (nder"!in$ entit!. c. Cannot easi"! %e o'erco)e %! indi'id(a" in'estors. d. Is considered rando).
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Purchasing-power Risk Default Risk 7 . The )ar,eta%"e sec(rities &ith the "east a)o(nt o de a("t ris, are 8E9 a. :edera" $o'ern)ent a$enc! sec(rities. c. Re*(rchase a$ree)ents. %. ;.S. Treas(r! sec(rities. d. Co))ercia" *a*er. CMA <=>1 1111 /=. The *ortion o the ris, that can %e e"i)inated %! di'ersi ication is ca""ed6 A. ;ni.(e ris, C. Interest rate ris, -. Mar,et ris, D. De a("t ris, Market Risk 4 . The t!*e o ris, that is not di'ersi ia%"e and e'en a ects the 'a"(e o a *ort o"io is 8E9 A. 3(rchasin$1*o&er ris,. C. Non)ar,et ris,. -. Mar,et ris,. D. Interest1rate ris,. Nonmarket Risk or ompan!-specific Risk /?. The (ni.(e ris, is a"so ca""ed the6 A. ;ns!ste)atic ris, -. Di'ersi ia%"e ris,
0hich o the o""o&in$ state)ents is correct2 8E9 a. 0e"" di'ersi ied stoc,ho"ders do not consider cor*orate ris, &hen deter)inin$ re.(ired rates o ret(rn. %. ;ndi'ersi ied stoc,ho"dersA inc"(din$ the o&ners o s)a"" %(sinessesA are )ore concerned a%o(t cor*orate ris, than )ar,et ris,. c. E)*irica" st(dies o the deter)inants o re.(ired rates o ret(rn 8,9 ha'e o(nd that on"! )ar,et ris, a ects stoc, *rices. d. Mar,et ris, is i)*ortant %(t does not ha'e a direct e ect on stoc, *rice %eca(se it on"! a ects %eta. e. A"" o the state)ents a%o'e are correct. -ri$ha) In theor!A the decision )a,er sho("d 'ie& )ar,et ris, as %ein$ o *ri)ar! i)*ortance. Bo&e'erA &ithin1 ir)A or cor*orateA ris, is re"e'ant to a ir)Cs8M9 a. 0e""1di'ersi ied stoc,ho"dersA %eca(se it )a! a ect de%t ca*acit! and o*eratin$ inco)e. %. Mana$e)entA %eca(se it a ects +o% sta%i"it!. c. CreditorsA %eca(se it a ects the ir)Cs credit &orthiness. d. State)ents a and c are correct. e. A"" o the state)ents a%o'e are correct. -ri$ha)
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Portfolio Risk Total Risk D . The ris, o a sin$"e asset is A. Non)ar,et ris,. -. Tota" ris,.
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C. 3ort o"io ris,. D. Mar,et ris,. C. Increasin$ ex*ected ret(rn.
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C. :ir) s*eci ic ris, D. A"" o the a%o'e
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An asset &ith hi$h ris, &i"" ha'e a8n9 A. 5o& ex*ected ret(rn.
R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
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MANAGEMENT ADVISORY SERVICES -. 5o&er *rice than an asset &ith "o& ris,.
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RISKS D. Bi$h standard de'iation o ret(rns. G"ei) %. c. d. e.

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. Ris, to a co)*an! is a ected %! %oth *ro+ect 'aria%i"it! and ho& *ro+ect ret(rns corre"ate &ith those o the co)*an!Cs *re'ai"in$ %(siness. O'era"" co)*an! ris, &i"" %e "o&est &hen a *ro+ectCs ret(rns exhi%it CIA 11D= IV17> a. 5o& 'aria%i"it! and ne$ati'e corre"ation. c. Bi$h 'aria%i"it! and *ositi'e corre"ation. %. 5o& 'aria%i"it! and *ositi'e corre"ation. d. Bi$h 'aria%i"it! and no corre"ation.
Sa"es *rice 'aria%i"it!. The extent to &hich o*eratin$ costs are ixed. Chan$es in re.(ired ret(rns d(e to inancin$ decisions. The a%i"it! to chan$e *rices as costs chan$e.
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"i#ui$it! Risk 11 . The ris, that sec(rities cannot %e so"d at a reasona%"e *rice on short notice is ca""ed A. De a("t ris,. C. 3(rchasin$1*o&er ris,. -. Interest1rate ris,. D. 5i.(idit! ris,. CIA 11>< IV1@1
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. 0hich o the o""o&in$ a ects a ir)Cs %(siness ris,2 8E9 a. The "e'e" o (ncertaint! a%o(t (t(re sa"es. %. The de$ree o o*eratin$ "e'era$e. c. The de$ree o inancia" "e'era$e. d. State)ents a and % are correct. e. A"" o the state)ents a%o'e are correct.
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. 0hen *(rchasin$ te)*orar! in'est)entsA &hich one o the o""o&in$ %est descri%es the ris, associated &ith the a%i"it! to se"" the in'est)ent in a short *eriod o ti)e &itho(t si$ni icant *rice concessions2 8E9 A. Interest rate ris,. C. :inancia" ris,. -. 3(rchasin$ *o&er ris,. D. 5i.(idit! ris,. CMA <=>? 1111
&inancial Risk I. 0hich o the o""o&in$ &o("d increase ris,2 8M9 a. Increase the "e'e" o &or,in$ ca*ita". %. Chan$e the co)*osition o &or,in$ ca*ita" to inc"(de )ore "i.(id assets. c. Increase the a)o(nt o short1ter) %orro&in$. d. Increase the a)o(nt o e.(it! inancin$.
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%usiness Risk 17 . -(siness ris, is the ris, inherent in a ir)Gs o*erations that exc"(des inancia" ris,. It de*ends on a"" o the o""o&in$ actors exce*t 8E9 A. A)o(nt o inancia" "e'era$e. C. De)and 'aria%i"it!. -. Sa"es *rice 'aria%i"it!. D. In*(t *rice 'aria%i"it!. G"ei)
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. -(siness ris, exc"(des s(ch actors as A. :inancia" ris,. -. A)o(nt o o*eratin$ "e'era$e.
. A ir)Cs inancia" ris, is a (nction o ho& it )ana$es and )aintains its de%t. 0hich one o the o""o&in$ sets o ratios characteri#es the ir) &ith the $reatest a)o(nt o inancia" ris,2 A. Bi$h de%t1to1e.(it! ratioA hi$h interest co'era$e ratioA sta%"e ret(rn on e.(it!. -. 5o& de%t1to1e.(it! ratioA "o& interest co'era$e ratioA 'o"ati"e ret(rn on e.(it!. C. Bi$h de%t1to1e.(it! ratioA "o& interest co'era$e ratioA 'o"ati"e ret(rn on e.(it!. D. 5o& de%t1to1e.(it! ratioA hi$h interest co'era$e ratioA sta%"e ret(rn on e.(it!. CMA 1/>1 11 4
C. De)and 'aria%i"it!. D. :"(ct(ations in s(**"iersG *rices.
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1. A decrease in the de%t ratio &i"" $enera""! ha'e no e ect on HHHHHHHHHH HHHHHH. 8E9 a. :inancia" ris,. %. Tota" ris,. c. -(siness ris,. d. Mar,et ris,. -ri$ha) /. -(siness ris, is concerned &ith the o*erations o the ir). 0hich o the o""o&in$ is not associated &ith 8or not a *art o 9 %(siness ris,2 8E9 a. De)and 'aria%i"it!. R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
%usiness an$ financial risk 7. 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. A ir)Cs %(siness ris, is so"e"! deter)ined %! the inancia" characteristics o its ind(str!. %. The actors that a ect a ir)Cs %(siness ris, are deter)ined *art"! %! ind(str! characteristics and *art"! %! econo)ic conditions. ;n ort(nate"!A these and other actors that a ect a ir)Cs %(siness ris, are not s(%+ect to an! de$ree o )ana$eria" contro". c. One o the %ene its to a ir) o %ein$ at or near its tar$et ca*ita" str(ct(re is that inancia" "exi%i"it! %eco)es )(ch "ess i)*ortant. d. The ir)Cs inancia" ris, )a! ha'e %oth )ar,et ris, and di'ersi ia%"e ris, co)*onents. -ri$ha) 3a$e / o @7
MANAGEMENT ADVISORY SERVICES E'change-rate Risk 1? . The ris, o "oss %eca(se o "(ct(ations in the re"ati'e 'a"(e o orei$n c(rrencies is ca""ed A. Ex*ro*riation ris,. C. M("tinationa" %eta. -. So'erei$n ris,. D. Exchan$e rate ris,. CIA 11>1 IV1=<
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RISKS . O & - Co)*an!A a ;.S. cor*orationA is in *ossession o acco(nts recei'a%"e deno)inated in Ger)an de(tsche )ar,s. To &hat t!*e o ris, are the! ex*osed2 8E9 A. 5i.(idit! ris,. C. Exchan$e1rate ris,. -. -(siness ris,. D. 3rice ris,. G"ei) . -onner E"ectronics has s(%sidiaries in se'era" internationa" "ocations and is concerned a%o(t its ex*os(re to orei$n exchan$e ris,. In co(ntries &here c(rrenc! 'a"(es are "i,e"! to a""A -onner sho("d enco(ra$e a"" o the o""o&in$ *o"icies exce*t A. Grantin$ trade credit &hene'er *ossi%"e. -. In'estin$ excess cash in in'entor! or other rea" assets. C. 3(rchasin$ )ateria"s and s(**"ies on a trade credit %asis. C:M Sa)*"e F. @ D. -orro&in$ "oca" c(rrenc! (nds i an a**ro*riate interest rate can %e o%tained. . A ir) )a! see, to a'oid exchan$e1rate ris, %! A. Maintainin$ a net )onetar! de%tor *osition in co(ntries &ith stren$thenin$ c(rrencies. -. Maintainin$ a net )onetar! creditor *osition in co(ntries &ith &ea,enin$ c(rrencies. C. A'oidin$ di'ersi ication o orei$n1c(rrenc! transactions. G"ei) D. -(!in$ or&ard exchan$e contracts to co'er "ia%i"ities deno)inated in a orei$n c(rrenc!.
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ultural Risk @=. A ;.S. )an( act(rer o &hich o the o""o&in$ $oods &o("d %e "i,e"! to ace the most c("t(ra" ris,s in o*eratin$ $"o%a""!2 a. :(rnit(re c. C"othin$ %. A(to)o%i"es d. :ood -ar ie"ds @?. A ;.S. )an( act(rer o &hich o the o""o&in$ $oods &o("d %e "i,e"! to ace the fewest c("t(ra" ris,s in o*eratin$ $"o%a""!2 a. To!s c. C"othin$ %. :ood d. :(rnit(re -ar ie"ds Political Risk @D. 0hich o the o""o&in$ &o("d %e considered a *o"itica" ris, in doin$ %(siness $"o%a""!2 a. Asset ex*ro*riation c. 0or,*"ace di'ersit! %. In "ation d. A"" o the a%o'e -ar ie"ds
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. 3o"itica" ris, )a! %e red(ced %! A. Enterin$ into a +oint 'ent(re &ith another orei$n co)*an!. 3a$e 7 o @7
MANAGEMENT ADVISORY SERVICES -. Ma,in$ orei$n o*erations de*endent on the do)estic *arent or techno"o$!A )ar,etsA and s(**"ies. C. Re (sin$ to *a! hi$her &a$es and hi$her taxes. D. :inancin$ &ith ca*ita" ro) a orei$n co(ntr!. G"ei) I. omprehensi(e A"" o the o""o&in$ state)ents are correct exce*t6 a. The )atchin$ o asset and "ia%i"it! )at(rities is considered desira%"e %eca(se this strate$! )ini)i#es interest rate ris,. %. De a("t ris, re ers to the ina%i"it! o the ir) to *a! o its )at(rin$ o%"i$ations. c. The )atchin$ o assets and "ia%i"it! )at(rities "o&ers de a("t ris,. d. An increase in the *a!a%"es de erra" *eriod &i"" "ead to a red(ction in the need to non1 s*ontaneo(s (ndin$. R3C3A 1<>@ RISK M)N)*EMENT MET+,DS Portfolio Theor! 1. 3ort o"io Theor! &as irst de'e"o*ed %!6 A. Merton Mi""er -. :ranco Modi$"iani 1/. A *ort o"io &i"" a (s(a""! contain6 A. One ris,"ess asset -. T&o or )ore assets
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C. Barr! Mar,o&it# D. Richard -reade! C. One ris,! asset D. None o the a%o'e
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Portfolio Management E icient 3ort o"io /@. E icient *ort o"ios are those &hich o er6 A. Bi$hest ex*ected ret(rn or a $i'en "e'e" o ris, -. Bi$hest ris, or a $i'en "e'e" o ex*ected ret(rn C. The )axi)() ris, and ex*ected ret(rn D. A"" o the a%o'e 77. E icient *ort o"ios are *ort o"ios that6 A. O er the hi$hest rate o ret(rn or a $i'en "e'e" o ris, -. O er the "o&est rate o ret(rn or a $i'en "e'e" o ris, C. O er the "o&est "e'e" o ris, or a $i'en rate o ret(rn D. A and C
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:easi%"e 3ort o"io // . A easi%"e *ort o"io that o ers the hi$hest ex*ected ret(rn or a $i'en ris, or the "east ris, or a $i'en ex*ected ret(rn is a8n9 A. O*ti)a" *ort o"io. C. E icient *ort o"io. -. Desira%"e *ort o"io. D. E ecti'e *ort o"io. G"ei) O*ti)a" 3ort o"io /7 . An o*ti)a" *ort o"io o in'est)ents is 8E9 A. E icient %eca(se it o ers the hi$hest ex*ected ret(rn. -. An! *ort o"io chosen ro) the e icient set o *ort o"ios. C. An! *ort o"io chosen ro) the easi%"e set o *ort o"ios. D. Tan$ent to the in'estorGs hi$hest indi erence c(r'e. R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
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RISKS S!ste)atic Ris, /? . Ca*ita" Asset 3ricin$ Theor! asserts that *ort o"io ret(rns are %est ex*"ained %!6 8E9 a. econo)ic actors. c. s!ste)atic ris,. %. s*eci ic ris,. d. di'ersi ication.
. A co)*an! (ses *ort o"io theor! to de'e"o* its in'est)ent *ort o"io. I the co)*an! &ishes to o%tain o*ti)a" ris, red(ction thro($h the *ort o"io e ectA it sho("d )a,e its next in'est)ent in A. An in'est)ent that corre"ates ne$ati'e"! to the c(rrent *ort o"io ho"din$s. -. An in'est)ent that is (ncorre"ated to the c(rrent *ort o"io ho"din$s. C. An in'est)ent that is hi$h"! corre"ated to the c(rrent *ort o"io ho"din$s. D. An in'est)ent that is *er ect"! corre"ated to the c(rrent *ort o"io ho"din$s. CIA <@>1 IV14D
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Mini)() Variance 3ort o"io /4. :"orida Co)*an! 8:C9 and Minnesota Co)*an! 8MC9 are %oth ser'ice co)*anies. Their historica" ret(rn or the *ast three !ears are6 :C6 11<JA1@JA /@JK MC6 1<JA =JA 7/J. 0hich *ort o"io is %etter2 A. 3ort o"io &ith @<J in :C and @<J in MC C. In'est)ent in :C -. Mini)() 'ariance *ort o"io D. None o the a%o'e -&M /=. Is the )ini)() 'ariance *ort o"io an e icient *ort o"io2 A. Yes C. Not necessari"! -. No 0e""1Di'ersi ied 3ort o"io 7<. In a &e"" di'ersi ied *ort o"ioA the t!*e o ris, re)ainin$ is6 A. Indi'id(a" sec(rit! ris, C. Tota" ris, -. Lero ris, D. Mar,et ris, 71. A &e""1di'ersi ied *ort o"io has ne$"i$i%"e6 A. S!ste)atic ris, -. ;ni.(e ris, C. Mar,et ris, D. None o the a%o'e
Standard De'iation 's. -eta Coe icient /7. Standard de'iation and %eta %oth )eas(re ris,A %(t the! are di erent in that 8E9 a. %eta )eas(res %oth s!ste)atic and (ns!ste)atic ris,. %. %eta )eas(res on"! s!ste)atic ris, &hi"e standard de'iation is a )eas(re o tota" is,. c. %eta )eas(res on"! (ns!ste)atic ris, &hi"e standard de'iation is a eas(re o tota" ris,. d. %eta )eas(res %oth s!ste)atic and (ns!ste)atic ris, &hi"e standard de'iation )eas(res on"! s!ste)atic ris,. -odie e. %eta )eas(res tota" ris, &hi"e standard de'iation )eas(res on"! nons!ste)atic ris,. Mar,et 3rice o Ris, /D . The )ar,et *rice o ris, 8M9 a. is the ris, *re)i() di'ided %! the standard de'iation o the )ar,et ret(rns. %. has a re&ard1to1ris, ratio o ME8rM 9 1 r NO/M. c. is the *rice o a ;. S. T1%i"". d. a and -. e. a and c.
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3ort o"io Matrix Ana"!sis /@ . 0hich one o the o""o&in$ *"annin$ techni.(es is )ost "i,e"! to %e (sed to deter)ine &hich %(siness (nits &i"" recei'e additiona" ca*ita" and &hich &i"" %e di'ested2 8D9 A. Co)*etiti'e strate$ies )ode". C. Scenario de'e"o*)ent. -. 3ort o"io )atrix ana"!sis. D. Sit(ationa" ana"!sis. CMA Sa)* F71> ;ns!ste)atic Ris, /= In a &e"" di'ersi ied *ort o"io 8M9 a. )ar,et ris, is ne$"i$i%"e. %. s!ste)atic ris, is ne$"i$i%"e. -odie c. (ns!ste)atic ris, is ne$"i$i%"e. d. nondi'ersi ia%"e ris, is ne$"i$i%"e.
Ris, 5e'e" o Sec(rities /> . 0hich o the o""o&in$ c"asses o sec(rities are "isted in order ro) "o&est ris,Oo**ort(nit! or ret(rn to hi$hest ris,Oo**ort(nit! or ret(rn2 8E9 A. ;.S. Treas(r! %ondsK cor*orate irst )ort$a$e %ondsK cor*orate inco)e %ondsK *re erred stoc,. -. Cor*orate inco)e %ondsK cor*orate )ort$a$e %ondsK con'erti%"e *re erred stoc,K s(%ordinated de%ent(res. C. Co))on stoc,K cor*orate irst )ort$a$e %ondsK cor*orate second )ort$a$e %ondsK cor*orate inco)e %onds. CIA <@D> IV14> D. 3re erred stoc,K co))on stoc,K cor*orate )ort$a$e %ondsK cor*orate de%ent(res. 1. 0hich o the o""o&in$ *ort o"ios ha'e the "east ris,2 A. A *ort o"io o treas(r! %i""s -. A *ort o"io o "on$ ter) ;nited States Go'ern)ent %onds C. Standard and 3oorGs co)*osite index D. 3ort o"io o co))on stoc,s o s)a"" ir)s
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RISKS -. 3(re *"a! ris, 8%eta9. C. The &ei$hted a'era$e o *ro+ect ris, 8%etas9. D. Acco(ntin$ ris, 8%eta9.
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. :ro) the 'ie&*oint o the in'estorA &hich o the o""o&in$ sec(rities *ro'ides the "east ris,2 a. Mort$a$e %ond. c. Inco)e %ond. %. S(%ordinated de%ent(re. d. De%ent(res. CIA 11>1 IV1@< . The ex*ected rate o ret(rn or the stoc, o Corn Enter*rises is /<JA &ith a standard de'iation o 1@J. The ex*ected rate o ret(rn or the stoc, o M(st Associates is 1<JA &ith a standard de'iation o >J. The ris,ier stoc, is A. Corn %eca(se its ret(rn is hi$her. -. Corn %eca(se its standard de'iation is hi$her. C. M(st %eca(se its standard de'iation is hi$her. D. M(st %eca(se its coe icient o 'ariation is hi$her. CMA <=>/ 11=
CIA <@>/ IV14>
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. A co)*an!Gs %eta 'a"(e has decreased %eca(se o a chan$e in its )ar,etin$ strate$!. Conse.(ent"!A the disco(nt rate a**"ied to ex*ected cash "o&s o *otentia" *ro+ects &i"" %e A. Red(ced. C. ;nchan$ed. -. Increased. D. Lero. CIA 11D@ IV1/=
3ort o"io -eta 7>. The %eta o )ar,et *ort o"io is6 A. < -. Q<.@ 4<. The %eta o a ris,1 ree *ort o"io is6 A. < -. Q<.@ 74. -eta o Treas(r! %i""s *ort o"io is6 A. Lero -. Q<.@
C. Q1.< D. R1.< C. Q1.< D. R1.< C. R1.< D. Q1.<
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Ris,! In'est)ent 's. Ris,"ess In'est)ent 7/ . The di erence %et&een the re.(ired rate o ret(rn on a $i'en ris,! in'est)ent and that on a ris,"ess in'est)ent &ith the sa)e ex*ected ret(rn is the A. Ris, *re)i(). C. Standard de'iation. -. Coe icient o 'ariation. D. -eta coe icient. CIA 11>/ IV14D Ca*ita" Asset 3ricin$ Mode" 77 . The ca*ita" asset *ricin$ )ode" dea"s &ith ris, and rates o ret(rn o a A. Sin$"e sec(rit!. -. Gro(* o sec(rities in a *ort o"io &hich o""o&s a %(! and ho"d strate$!. C. 3ort o"io and ho& a ne& sec(rit! a ects that *ort o"io. D. Sin$"e ixed asset.
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CIA <@D@ IV1/D
Accordin$ to the Ca*ita" Asset 3ricin$ Mode" 8CA3M9 a &e"" di'ersi ied *ort o"ioGs rate o ret(rn is a (nction o 8E9 a. )ar,et ris, c. (ni.(e ris,. %. (ns!ste)atic ris, d. rein'est)ent ris,. -odie
44. A stoc, &ith a %eta o #ero &o("d %e ex*ected to6 A. Ba'e a rate o ret(rn e.(a" to the ris,1 ree rate -. Ba'e a rate o ret(rn e.(a" to the )ar,et ris, *re)i() C. Ba'e a rate o ret(rn e.(a" to #ero D. Ba'e a rate o ret(rn e.(a" to the )ar,et rate o ret(rn
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-eta Coe icient 7?. The P%etaP is a )eas(re o 6 A. ;ni.(e ris, -. Mar,et ris,
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E.(it! -eta 7?. I %eta o de%t is #eroA then the %eta o e.(it! is e.(a" to6 A. 81 Q De%t1e.(it! ratio98%eta o assets9 C. 8-eta o assets9O8de%t1e.(it! ratio9 -. 8De%t1e.(it! ratio98%eta o assets9 D. None o the a%o'e -&M 7?. In )an! sit(ations de%t %eta can %e sa e"! ass()ed to %e #ero. ;nder this ass()*tionA e.(it! %eta can %e ex*ressed as6 ME S )ar,et 'a"(e o e.(it! and D S )ar,et 'a"(e o de%tN A. e.(it! %eta S 8118DOE.9 8asset %eta9 C. e.(it! %eta S 8asset %eta9O81Q8DOE.9 -. e.(it! %eta S 81Q8DOE.9 8asset %eta9 D. None o the a%o'e -&M 3a$e = o @7
C. Tota" ris, D. None o the a%o'e
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. The "e'e" o ris, that concerns in'estors &ho s(**"! ca*ita" to a di'ersi ied co)*an! is A. 3ro+ect ris, 8%eta9.
MANAGEMENT ADVISORY SERVICES Asset -etaA De%t -eta & E.(it! -eta 7/. 0hich o the o""o&in$ is tr(e2 A. %D T %A T %E -. %E T %A T %D 74. 0hich o the o""o&in$ is tr(e2 A. %D U %A U %E -. %E U %A U %D
RISKS Variance /?. In the or)("a or ca"c("atin$ the 'ariance o an asset *ort o"ioA ho& )an! are co'ariance ter)s2 A. MN8N119NO/ C. N -. NV/ D. None o the a%o'e -&M /D. In the or)("a or ca"c("atin$ the 'ariance o an N1asset *ort o"ioA ho& )an! are 'ariance ter)s2 A. MN8N119NO/ C. N -. NV/ D. None o the a%o'e -&M 7/. The 'ariance or)("a or a o(r stoc, *ort o"io contains6 A. 4 indi'id(a" 'ariance ter)s and = (ni.(e co'ariance ter)s -. 7 indi'id(a" 'ariance ter)s and = (ni.(e co'ariance ter)s C. = indi'id(a" 'ariance ter)s and > (ni.(e co'ariance ter)s D. = indi'id(a" 'ariance ter)s and = (ni.(e co'ariance ter)s
C. %A T %E T %D D. None o the a%o'e are tr(e
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C. %A U %E U %D D. None o the a%o'e are tr(e
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Standard De'iation 7D. The 'ariance or standard de'iation is a )eas(re o 6 A. Tota" ris, C. Mar,et ris, -. ;ni.(e ris, D. None o the a%o'e
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/. In'est)ents A and - %oth o er an ex*ected rate o ret(rn o 1/J. I the standard de'iation o A is /<J and that o - is 7<JA then in'estors &o("d6 A. 3re er A to -. 3re er - to A C. 3re er a *ort o"io o A and D. Cannot ans&er &itho(t ,no&in$ in'estorGs ris, *re erences -&M Coe icient o Variation /4. 0hich o the o""o&in$ can %e co)*(ted and co)*ared or each a"ternati'e to deter)ine the re"ati'e ris,iness o in'est)ents that ha'e di erent "e'e"s o ex*ected ret(rn2 A. coe icient o 'ariation C. standard de'iation -. 'ariance D. ex*ected 'a"(e Carter & ;sr!
7?
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Co'ariance 7D . 0hich o the o""o&in$ s*eci ica""! )eas(res the 'o"ati"it! o ret(rns to$ether &ith their corre"ation &ith the ret(rns o other sec(rities2 8M9 A. Variance. C. Coe icient o 'ariation. -. Standard de'iation. D. Co'ariance. G"ei)
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. I the co'ariance o stoc, A &ith stoc, - is 1.<<?=A then &hat is the co'ariance o stoc, - &ith stoc, A2 A. Q.<<?= C. Greater than .<<?=. -. 1.<<?= D. 5ess than 1.<<?=. G"ei)
. The ex*ected rate o ret(rn or the stoc, o Cornh(s,er Enter*rises is /<JA &ith a standard de'iation o 1@J. The ex*ected rate o ret(rn or the stoc, o M(stan$ Associates is 1<J &ith a standard de'iation o >J. The ris,ier stoc, is 8M9 a. Cornh(s,er %eca(se the ret(rn is hi$her. %. Cornh(s,er %eca(se the standard de'iation is hi$her. c. M(stan$ %eca(se the standard de'iation is hi$her. d. M(stan$ %eca(se the ret(rn is "o&er. e. M(stan$ %eca(se the coe icient o 'ariation is hi$her. CMA <=>/ 11=
Indi erence C(r'e 4< . An indi erence c(r'e re*resents co)%inations o *ort o"ios ha'in$ e.(a" (ti"it! to the in'estor. Gi'en that ris, and ret(rns are *"otted on the hori#onta" and 'ertica" axesA res*ecti'e"!A and that the in'estor is ris, a'erseA the c(r'e has A. An increasin$"! stee*er s"o*e i the in'estor is "ess ris, a'erse. -. A decreasin$"! ne$ati'e s"o*e i the in'estorGs (ti"it! increases. C. An increasin$"! *ositi'e s"o*e. D. A decreasin$"! *ositi'e s"o*e. G"ei)
3a$e ? o @7
MANAGEMENT ADVISORY SERVICES Ex*ected Rate o Ret(rn 7. 0hen stoc,s &ith the sa)e ex*ected ret(rn are co)%ined into a *ort o"ioA the ex*ected ret(rn o the *ort o"io is6 A. 5ess than the a'era$e ex*ected ret(rn 'a"(e o the stoc,s -. Greater than the a'era$e ex*ected ret(rn o the stoc,s C. E.(a" to the a'era$e ex*ected ret(rn o the stoc,s D. I)*ossi%"e to *redict -&M
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RISKS A. Q1 -. < C. R<.@ D. R1 -&M
11. Maxi)() di'ersi ication is o%tained %! co)%inin$ t&o stoc,s &ith a corre"ation coe icient e.(a" to6 A. Q1.< C. R1.< -. <.< D. Q<.@ -&M Corre"ation >. The corre"ation )eas(res the6 A. Rate o )o'e)ents o the ret(rn o indi'id(a" stoc,s -. Direction o )o'e)ent o the ret(rn o indi'id(a" stoc,s C. Direction o )o'e)ent %et&een the ret(rns o t&o stoc,s D. Stoc, )ar,et 'o"ati"it!
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. An in'estor (ses the ca*ita" asset *ricin$ )ode" 8CA3M9 to e'a"(ate the ris,1ret(rn re"ationshi* on a *ort o"io o stoc,s he"d as an in'est)ent. 0hich o the o""o&in$ &o("d not %e (sed to esti)ate the *ort o"ioGs ex*ected rate o ret(rn2 8D9 A. Ex*ected ris, *re)i() on the *ort o"io o stoc,s. -. Interest rate or the sa est *ossi%"e in'est)ent. C. Ex*ected rate o ret(rn on the )ar,et *ort o"io. D. Standard de'iation o the )ar,et ret(rns. CIA 11>7 IV14?
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Ex*ected Ret(rn R -eta Re"ationshi* /@. The ex*ected ret(rn1%eta re"ationshi* 8M9 a. is the )ost a)i"iar ex*ression o the CA3M to *ractitioners. %. re ers to the &a! in &hich the co'ariance %et&een the ret(rns on a stoc, and ret(rns on the )ar,et )eas(res the contri%(tion o the stoc, to the 'ariance o the )ar,et *ort o"ioA &hich is %eta. c. ass()es that in'estors ho"d &e""1di'ersi ied *ort o"ios d. a"" o the a%o'e are tr(e. -odie Co)*rehensi'e 1/ Accordin$ to the Ca*ita" Asset 3ricin$ Mode" 8CA3M9A &hich one o the o""o&in$ state)ents is a"se2 8M9 a. The ex*ected rate o ret(rn on a sec(rit! decreases in direct *ro*ortion to a decrease n the ris,1 ree rate. %. The ex*ected rate o ret(rn on a sec(rit! increases direct"! &ith its %eta. c. A air"! *riced sec(rit! has an a"*ha o #ero. d. In e.(i"i%ri()A a"" sec(rities "ie on the sec(rit! )ar,et "ine. -odie Two-Stocks Portfolio Corre"ation Coe icient 7=. :or a t&o1stoc, *ort o"ioA the )axi)() red(ction in ris, occ(rs &hen the corre"ation coe icient %et&een the t&o stoc,s is6 R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
. The ret(rns on t&o stoc,s can %e corre"ated in 'a"(es exce*t those that are A. 3ositi'e. C. Ne(tra". -. Ne$ati'e. D. S,e&ed.
G"ei)
Variance />. I the corre"ation %et&een t&o stoc,s is Q1A then a *ort o"io co)%inin$ these t&o stoc,s &i"" ha'e 'ariance that is6 A. 5ess than the &ei$hted a'era$e o the t&o indi'id(a" 'ariances -. More than the &ei$hted a'era$e o the t&o indi'id(a" 'ariances C. E.(a" to the &ei$hted a'era$e o the t&o indi'id(a" 'ariances D. None o the a%o'e -&M Ex*ected Ret(rn 4. Stoc, A has an ex*ected ret(rn o /<JA and stoc, - has an ex*ected ret(rn o 1/J. The ris, o Stoc, A as )eas(red %! the 'ariance o the ret(rns is t&ice that o stoc, -. I the t&o stoc,s are co)%ined e.(a""! in a *ort o"ioA &hat &o("d %e the ex*ected ret(rn o the *ort o"io2 A. 1=J C. /<J -. 1/J D. Need )ore in or)ation to ans&er - & M +e$ging 47 . 0hen a ir) inances each asset &ith a inancia" instr()ent o the sa)e a**roxi)ate )at(rit! as the "i e o the assetA it is a**"!in$ 3a$e D o @7
MANAGEMENT ADVISORY SERVICES A. 0or,in$ ca*ita" )ana$e)ent. -. Ret(rn )axi)i#ation.

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RISKS C. :inancia" "e'era$e. D. A hed$in$ a**roach. C. No Yes CMA 1/>1 1117 D. No No C. A co))it)ent toda! to *(rchase a *rod(ct on a s*eci ic (t(re date at a *rice deter)ined toda!. D. A co))it)ent toda! to *(rchase a *rod(ct on"! &hen its *rice increases a%o'e its c(rrent exercise *rice. G"ei)
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. Contracts to hed$e ris, %! exchan$in$ cash "o&s inc"(de 8E9 G"ei) A. -. Interest1Rate S&a*s Yes Yes C(rrenc! S&a*s Yes No . The (se o deri'ati'es to either hed$e or s*ec("ate res("ts in A. Increased ris, re$ard"ess o )oti'e. -. Decreased ris, re$ard"ess o )oti'e. C. O set ris, &hen hed$in$ and increased ris, &hen s*ec("atin$. D. O set ris, &hen s*ec("atin$ and increased ris, &hen hed$in$.
4@
G"ei)
. I a cor*oration ho"ds a or&ard contract or the de"i'er! o ;.S. Treas(r! %onds in = )onths andA d(rin$ those = )onthsA interest rates dec"ineA at the end o the = )onths the 'a"(e o the or&ard contract &i"" ha'e A. Decreased. -. Increased. C. Re)ained constant. D. An! o the ans&ers )a! %e correctA de*endin$ on the extent o the dec"ine in interest rates. G"ei)
4=
. A co)*an! has recent"! *(rchased so)e stoc, o a co)*etitor as *art o a "on$1ter) *"an to ac.(ire the co)*etitor. Bo&e'erA it is so)e&hat concerned that the )ar,et *rice o this stoc, co("d decrease o'er the short r(n. The co)*an! co("d hed$e a$ainst the *ossi%"e dec"ine in the stoc,Gs )ar,et *rice %! CIA <@>< IV1@? A. 3(rchasin$ a ca"" o*tion on that stoc,. C. Se""in$ a *(t o*tion on that stoc,. -. 3(rchasin$ a *(t o*tion on that stoc,. D. O%tainin$ a &arrant o*tion on that stoc,.
&utures ontract @< . A distin$(ishin$ eat(re o a (t(res contract is that A. 3er or)ance is de"a!ed. C. De"i'er! is to %e on a s*eci ic da!. G"ei) -. It is a hed$eA not a s*ec("ation. D. The *rice is )ar,ed to )ar,et each da!.
@1
Duration +e$ging 4? . D(ration hed$in$ in'o"'es hed$in$ interest1rate ris, %! )atchin$ the d(ration o assets &ith the d(ration o "ia%i"ities. 0hich o the o""o&in$ is a tr(e state)ent a%o(t d(ration hed$in$2 8M9 A. I d(ration increasesA the 'o"ati"it! o the *rice o a de%t instr()ent decreases. -. The $oa" o d(ration hed$in$ is to e.(ate the d(ration o assets &ith the d(ration o "ia%i"ities. C. The ir) is i))(ni#ed a$ainst interest1rate ris, &hen the tota" *rice chan$e or assets e.(a"s the tota" *rice chan$e or "ia%i"ities. D. D(ration is hi$her i the no)ina" rate on a de%t instr()ent is hi$her. G"ei) &orwar$ ontract 4D . A or&ard contract in'o"'es 8E9 A. A co))it)ent toda! to *(rchase a *rod(ct on a s*eci ic (t(re date at a *rice to %e deter)ined so)e ti)e in the (t(re. -. A co))it)ent toda! to *(rchase a *rod(ct so)e ti)e d(rin$ the c(rrent da! at its *resent *rice. R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
. An a(to)o%i"e co)*an! that (ses the (t(res )ar,et to set the *rice o stee" to *rotect a *ro it a$ainst *rice increases is an exa)*"e o A. A short hed$e. -. A "on$ hed$e. C. Se""in$ (t(res to *rotect the co)*an! ro) "oss. D. Se""in$ (t(res to *rotect a$ainst *rice dec"ines. G"ei)
Interest rate futures contract Interest rate Swap @/ . In an interest rate s&a*A the irst co)*an! A. Se""s its ri$ht to "o& interest rate inancin$ at a inancia" instit(tion to the second co)*an! that is see,in$ to %orro& (nds. -. A$rees to ser'ice the de%t o the second co)*an! %! )a,in$ interest *a!)ents direct"! to the %an, o the second co)*an!A &hi"e the second co)*an! a$rees in exchan$e to )a,e interest *a!)ents to the %an, o the irst co)*an!. C. -(!s the o(tstandin$ *(%"ic de%t o the second co)*an! and s&a*s the interest *a!)ents it recei'es on that de%t or the interest *a!)ents it )(st )a,e on its o&n de%t.
3a$e > o @7
MANAGEMENT ADVISORY SERVICES D. A$rees to exchan$e &ith the second co)*an! the di erence %et&een the interest char$es on its o&n %orro&in$s and the interest char$es on the %orro&in$s o the second co)*an!. CIA <@>= IV1/> Interest Rate . urrenc! Swap @7 . Contracts to hed$e ris, %! exchan$in$ cash "o&s inc"(de G"ei) A. -. Interest1Rate S&a*s Yes Yes C(rrenc! S&a*s Yes No
RISKS RISK-)D12STED DIS ,2NT R)TE @= . Me$a Inc.A a "ar$e con$"o)erate &ith o*eratin$ di'isions in )an! ind(striesA (ses ris,1ad+(sted disco(nt rates in e'a"(atin$ ca*ita" in'est)ent decisions. Consider the o""o&in$ state)ents concernin$ Me$aGs (se o ris,1ad+(sted disco(nt rates. I. Me$a )a! acce*t so)e in'est)ents &ith interna" rates o ret(rn "ess than Me$aGs o'era"" a'era$e cost o ca*ita". II. Disco(nt rates 'ar! de*endin$ on the t!*e o in'est)ent. III. Me$a )a! re+ect so)e in'est)ents &ith interna" rates o ret(rn $reater than the cost o ca*ita". IV. Disco(nt rates )a! 'ar! de*endin$ on the di'ision. 0hich o the a%o'e state)ents are correct2 8D9 A. I and III on"!. C. IIA IIIA and IV on"!. -. II and IV on"!. D. IA IIA IIIA and IV. CMA Sa)* F41@
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C. No Yes
D. No No
MET+,DS ,& )N)"/0IN* RISK Sensiti(it! )nal!sis @4 . 0hich o the o""o&in$ a**roaches &o("d %est ana"!#e the ris, o increasin$ the *rice o a ta%"e %! W@<2 8E9 A. Sensiti'it! ana"!sis. C. In or)a" )ethod. -. Si)("ation ana"!sis. D. Certaint! e.(i'a"ent ad+(st)ents. G"ei) Simulation )nal!sis @@ . 0hich )ethod or )eas(rin$ ris, considers %oth the sensiti'it! o chan$in$ N3Vs and the ran$e o 'a"(es o the 'aria%"es that are chan$ed2 A. Si)("ation ana"!sis. C. Sensiti'it! ana"!sis. -. The Ca*ita" Asset 3ricin$ Mode". D. Certaint! e.(i'a"ent ad+(st)ents. G"ei) )nal!sis of Pricing Techni#ue @<. The acron!) A3T stands or6 A. Ar%itra$e 3ricin$ Mode" -. Asset 3ricin$ Too"
C. Ana"!sis o 3ricin$ Techni.(e D. Ana"!sis 3ricin$ Theor!
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@1. A P actorP in A3T is a 'aria%"e that6 A. A ects the ret(rn o ris,! assets in a s!ste)atic )anner -. Corre"ates &ith ris,! asset ret(rns in an (ns!ste)atic )anner C. Is *(re"! PnoiseP D. A ects the ret(rn o a ris,! asset in a rando) )anner Three-factor Mo$el @@. The three actors in the Three1:actor Mode" are6 A. Mar,et actor C. -oo,1to1)ar,et actor -. Si#e actor D. A"" o the a%o'e R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
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. Dic, -oe Enter*risesA an a""1e.(it! ir)A has a cor*orate %eta coe icient o 1.@. The inancia" )ana$er is e'a"(atin$ a *ro+ect &ith an ex*ected ret(rn o /1 *ercentA %e ore an! ris, ad+(st)ent. The ris,1 ree rate is 1< *ercentA and the re.(ired rate o ret(rn on the )ar,et is 1= *ercent. The *ro+ect %ein$ e'a"(ated is ris,ier than -oeCs a'era$e *ro+ectA in ter)s o %oth %eta ris, and tota" ris,. 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. The *ro+ect sho("d %e acce*ted since its ex*ected ret(rn 8%e ore ris, ad+(st)ent9 is $reater than its re.(ired ret(rn. %. The *ro+ect sho("d %e re+ected since its ex*ected ret(rn 8%e ore ris, ad+(st)ent9 is "ess than its re.(ired ret(rn. c. The acce*tOre+ect decision de*ends on the ris,1ad+(st)ent *o"ic! o the ir). I the ir)Cs *o"ic! &ere to red(ce a ris,ier1than1a'era$e *ro+ectCs ex*ected ret(rn %! 1 *ercenta$e *ointA then the *ro+ect sho("d %e acce*ted. d. Ris,ier1than1a'era$e *ro+ects sho("d ha'e their ex*ected ret(rns increased to re "ect their added ris,iness. C"ear"!A this &o("d )a,e the *ro+ect acce*ta%"e re$ard"ess o the a)o(nt o the ad+(st)ent. e. 3ro+ects sho("d %e e'a"(ated on the %asis o their tota" ris, a"one. Th(sA there is ins( i1 cient in or)ation in the *ro%"e) to )a,e an acce*tOre+ect decision. -ri$ha) . Ass()e !o( are the director o ca*ita" %(d$etin$ or an a""1e.(it! ir). The ir)Cs c(rrent cost o e.(it! is 1= *ercentK the ris,1 ree rate is 1< *ercentK and the )ar,et ris, *re)i() is @ *ercent. Yo( are considerin$ a ne& *ro+ect that has @< *ercent )ore %eta ris, than !o(r ir)Cs assets c(rrent"! ha'eA that isA its %eta is @< *ercent "ar$er than the ir)Cs existin$ %eta. The 3a$e 1< o @7
@D
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MANAGEMENT ADVISORY SERVICES ex*ected ret(rn on the ne& *ro+ect is 1D *ercent. Sho("d the *ro+ect %e acce*ted i %eta ris, is the a**ro*riate ris, )eas(re2 Choose the correct state)ent. 8M9 a. YesK its ex*ected ret(rn is $reater than the ir)Cs cost o ca*ita". %. YesK the *ro+ectCs ris,1ad+(sted re.(ired ret(rn is "ess than its ex*ected ret(rn. c. NoK a @< *ercent increase in %eta ris, $i'es a ris,1ad+(sted re.(ired ret(rn o /4 *ercent. d. NoK the *ro+ectCs ris,1ad+(sted re.(ired ret(rn is / *ercenta$e *oints a%o'e its ex*ected ret(rn. e. NoK the *ro+ectCs ris,1ad+(sted re.(ired ret(rn is 1 *ercenta$e *oint a%o'e its ex*ected ret(rn. -ri$ha)
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RISKS /=. A do""ar no& is &orth )ore than a do""ar to %e recei'ed in the (t(re %eca(se o a. In "ation. c. The o**ort(nit! cost o &aitin$. %. ;ncertaint!. d. None o the a%o'e.
=<
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. The theor! (nder"!in$ the cost o ca*ita" is *ri)ari"! concerned &ith the cost o A. 5on$1ter) (nds and o"d (nds. -. Short1ter) (nds and ne& (nds. C. 5on$1ter) (nds and ne& (nds. D. An! co)%ination o o"d or ne&A short1ter) or "on$1ter) (nds. CMA <=>/ 1117 . Mana$e)ent ,no&"ed$e o the cost o ca*ita" is (se (" or each o the o""o&in$ exce*t 8D9 a. Ma,in$ ca*ita" in'est)ent decisions. %. Mana$in$ &or,in$ ca*ita". c. Settin$ the )axi)() rate o ret(rn on ne& in'est)ents. d. E'a"(atin$ *er or)ance. G"ei) . In re errin$ to the $ra*h o a ir)Gs cost o ca*ita"A i e is the c(rrent *ositionA &hich one o the o""o&in$ state)ents %est ex*"ains the sa(cer or ;1sha*ed c(r'e2
. Ass()e !o( are the director o ca*ita" %(d$etin$ or an a""1e.(it! ir). The ir)Cs c(rrent cost o e.(it! is 1= *ercentK the ris,1 ree rate is 1< *ercentK and the )ar,et ris, *re)i() is @ *ercent. Yo( are considerin$ a ne& *ro+ect that has @< *ercent )ore %eta ris, than !o(r ir)Cs assets c(rrent"! ha'eA that isA its %eta is @< *ercent "ar$er than the ir)Cs existin$ %eta. The ex*ected ret(rn on the ne& *ro+ect is 1D *ercent. Sho("d the *ro+ect %e acce*ted i %eta ris, is the a**ro*riate ris, )eas(re2 Choose the correct state)ent. 8M9 a. YesK its ex*ected ret(rn is $reater than the ir)Cs cost o ca*ita". %. YesK the *ro+ectCs ris,1ad+(sted re.(ired ret(rn is "ess than its ex*ected ret(rn. c. NoK a @< *ercent increase in %eta ris, $i'es a ris,1ad+(sted re.(ired ret(rn o /4 *ercent. d. NoK the *ro+ectCs ris,1ad+(sted re.(ired ret(rn is / *ercenta$e *oints a%o'e its ex*ected ret(rn. e. NoK the *ro+ectCs ris,1ad+(sted re.(ired ret(rn is 1 *ercenta$e *oint a%o'e its ex*ected ret(rn. -ri$ha)
=1
=/
Cost o Ca*ita" 8*ercent9 e De%t1to1E.(it! Ratio A. The co)*osition o de%t and e.(it! does not a ect the ir)Gs cost o ca*ita". -. The cost o ca*ita" is a")ost a"&a!s a'ora%"! in "(enced %! increases in inancia" "e'era$e. C. The inancia" )ar,ets &i"" *ena"i#e ir)s that %orro& e'en in )oderate a)o(nts. D. ;se o at "east so)e de%t inancin$ &i"" enhance the 'a"(e o the ir). CMA 1/DD 11@ /=. The *re1tax cost o ca*ita" is hi$her than the a ter1tax cost o ca*ita" %eca(se 8E9 a. interest ex*ense is ded(cti%"e or tax *(r*oses. %. *rinci*a" *a!)ents on de%t are ded(cti%"e or tax *(r*oses. c. the cost o ca*ita" is a ded(cti%"e ex*ense or tax *(r*oses. 3a$e 11 o @7
,ST ,& )PIT)" 4/. Cost o ca*ita" is 8E9 a. The interest rate an entit! )(st *a! to %orro& )one!. %. The ret(rn an entit!Cs stoc,ho"ders ex*ect on their in'est)ent . c. The rate o ret(rn the entit! can earn ro) in'estin$ a'ai"a%"e cash. d. A conce*t o )ana$eria" inance incor*oratin$ a"" o the a%o'e.
5&B
17. Cost o ca*ita" is a. The a)o(nt the co)*an! )(st *a! or its *"ant assets. %. The di'idends a co)*an! )(st *a! on its e.(it! sec(rities. c. The cost the co)*an! )(st inc(r to o%tain its ca*ita" reso(rces. d. The cost the co)*an! is char$ed %! in'est)ent %an,ers &ho hand"e the iss(ance o e.(it! or "on$1ter) de%t sec(rities. 5&B R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
MANAGEMENT ADVISORY SERVICES d. di'idend *a!)ents to stoc,ho"ders are ded(cti%"e or tax *(r*oses.
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RISKS -ar ie"d a. %. c. d.

=@
. The o'era"" cost o ca*ita" is the A. Rate o ret(rn on assets that co'ers the costs associated &ith the (nds e)*"o!ed. -. A'era$e rate o ret(rn a ir) earns on its assets. C. Mini)() rate a ir) )(st earn on hi$h1ris, *ro+ects. D. Cost o the ir)Gs e.(it! ca*ita" at &hich the )ar,et 'a"(e o the ir) &i"" re)ain (nchan$ed. CMA <=>/ 1111 0hich o these state)ents are *ertinent to cost o ca*ita"2 8D9 1. It is the ex*ected ret(rn that in'estors de)and or a $i'en "e'e" o ris,. /. It )a! %e e)*"o!ed as a %ench)ar, or the e'a"(ation o *er or)ance. 7. :or in'est)ent decisionsA it )(st %e %ased on the c(rrent or *ros*ecti'e cost o the 'ario(s ca*ita" co)*onents rather than on their historica" costs. 4. It )a! a"so %e (sed in ac.(isition ana"!sisA "i.(idation st(dies and so(rce o inancin$ decisions. @. It )a! di er ro) the h(rd"e rate (sed to re "ect re"ati'e ris, attri%(ted to a s*eci ic *ro+ectA di'isionA or %(siness (nit. R3C3A 1<>4 a. A"" i'e state)ents. c. State)ents 1A /A 7A and 4 on"!. %. State)ents 1A / and 7 on"!. d. State)ents 1A /A 4 and @ on"!.
The stated interest *aid on a %an, "oan. Assets that are considered o%so"ete that )aintain a net %oo, 'a"(e. Dece"erated de*reciation. 5endin$ (nds to a s(**"ier at a "o&er1than1)ar,et rate in exchan$e or recei'in$ the s(**"ierCs *rod(cts at a disco(nt. CMA <=D> 11/@
I.
. The ex*"icit cost o de%t inancin$ is the interest ex*ense. The i)*"icit cost8s9 o de%t inancin$ is 8are9 the 8D9 a. Increase in the cost o de%t as the de%t1to1e.(it! ratio increases. %. Increases in the cost o de%t and e.(it! as the de%t1to1e.(it! ratio increases. c. Increase in the cost o e.(it! as the de%t1to1e.(it! ratio decreases. CMA 1/>1 11/ d. Decrease in the &ei$hted1a'era$e cost o ca*ita" as the de%t1to1e.(it! ratio increases.
/4. 0hich o the o""o&in$ is tr(e2 a. Co)*anies can raise co))on e.(it! on"! %! iss(in$ ne& shares o co))on stoc,. %. There is no o**ort(nit! cost associated &ith (se o retained earnin$s as a so(rce o co))on e.(it!. c. Most "ar$e )at(re ir)s iss(e ne& shares o co))on stoc, on a re$("ar %asis. d. Co)*anies can raise co))on e.(it! %! iss(in$ ne& shares o co))on stoc, and thro($h retained earnin$s. SA S & S /@. 0hich o the o""o&in$ is incorrect2 a. The a ter1tax cost o de%t or a ir) &ith "osses is e.(a" to the interest rate on the de%t. %. Most de%t is *"aced *ri'ate"! and th(s there is no "otation cost. c. :"otation costs or *re erred stoc, are hi$her than or de%t. d. :ir)s a"&a!s *a! di'idends on their co))on stoc, iss(es %eca(se o the ease &ith &hich co))on shareho"ders can ass()e contro" o the ir). SA S & S Impute$ osts (s3 E'plicit osts =4 . A"" o the o""o&in$ are exa)*"es o i)*(ted costs exce*t 8M9 R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS 3a$e 1/ o @7

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RISKS II. III. IV. V. a. %. I. The co(*on rate on the %ond is $reater than the )ar,et rate o interest. The co(*on rate and the )ar,et rate are e.(a". The %ond se""s at a *re)i(). The %ond se""s at a disco(nt. I and IV. c. II and IV. I and V. d. II and V.
ost of De-t apital . 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. Since the )one! is readi"! a'ai"a%"eA the cost o retained earnin$s is (s(a""! a "ot chea*er than the cost o de%t inancin$. %. 0hen ca"c("atin$ the cost o *re erred stoc,A a co)*an! needs to ad+(st or taxesA %eca(se *re erred stoc, di'idends are tax ded(cti%"e. c. 0hen ca"c("atin$ the cost o de%tA a co)*an! needs to ad+(st or taxesA %eca(se interest *a!)ents are tax ded(cti%"e. d. State)ents a and % are correct. e. State)ents % and c are correct. -ri$ha) . In co)*(tin$ the cost o ca*ita"A the cost o de%t ca*ita" is deter)ined %! 8E9 a. Ann(a" interest *a!)ent di'ided %! the *roceeds ro) de%t iss(ance. %. Interest rate ti)es 81 R the ir)Cs tax rate9 c. Ann(a" interest *a!)ent di'ided %! the %oo, 'a"(e o the de%t. d. The ca*ita" asset *ricin$ )ode".
CMA <=>@ 11=
=?
I the ret(rn on tota" assets is 1<J and i the ret(rn on co))on stoc,ho"dersC e.(it! is 1/J then 8D9 a. The a ter1tax cost o "on$1ter) de%t is *ro%a%"! $reater than 1<J. %. The a ter1tax cost o "on$1ter) de%t is 1/J. c. 5e'era$e is ne$ati'e. d. The a ter1tax cost o "on$1ter) de%t is *ro%a%"! "ess than 1<J. R3C3A 1<>@ 0hich o the o""o&in$ state)ents is )ost correct2 8M9 a. S(**ose a ir) is "osin$ )one! and th(sA is not *a!in$ taxesA and that this sit(ation is ex*ected to *ersist or a e& !ears &hether or not the ir) (ses de%t inancin$. Then the ir)Cs a ter1tax cost o de%t &i"" e.(a" its %e ore1tax cost o de%t. %. The co)*onent cost o *re erred stoc, is ex*ressed as , *81 1 T9A %eca(se *re erred stoc, di'idends are treated as ixed char$esA si)i"ar to the treat)ent o de%t interest. c. The reason that a cost is assi$ned to retained earnin$s is %eca(se these (nds are a"read! earnin$ a ret(rn in the %(sinessK the reason does not in'o"'e the o**ort(nit! cost *rinci*"e. -ri$ha) d. The %ond1!ie"d1*"(s1ris,1*re)i() a**roach to esti)atin$ a ir)Cs cost o co))on e.(it! in'o"'es addin$ a s(%+ecti'e"! deter)ined ris,1*re)i() to the )ar,et ris,1 ree %ond rate. de%t or a ir) is de ined as the interest rate on U5ist AT de%t )in(s the 5ist A Ne& O(tstandin$ Ne& O(tstandin$ 5ist :ir)Gs )ar$ina" tax rate :ir)Gs )ar$ina" tax rate Interest rate ti)es the ir)Gs )ar$ina" tax rate Interest rate ti)es the ir)Gs )ar$ina" tax rate
. G"ei)
=D
. I , is the cost o de%t and t is the )ar$ina" tax rateA the a ter1tax cost o de%t ,A is %est re*resented %! the or)("a a. ,i S ,Ot c. ,i S ,8t9 %. ,i S,O81 R t9 d. ,i S , 81 R t9 CMA 1/DD 117 . I -re&er Cor*orationGs %onds are c(rrent"! !ie"din$ DJ in the )ar,et*"aceA &h! is the ir)Gs cost o de%t "o&er2 8E9 A. Mar,et interest rates ha'e increased. -. Additiona" de%t can %e iss(ed )ore chea*"! than the ori$ina" de%t. C. There sho("d %e no di erenceK cost o de%t is the sa)e as the %ondsG )ar,et !ie"d. D. Interest is ded(cti%"e or tax *(r*oses. CMA <=>/ 111/ The interest rate on the %onds is $reater or the second a"ternati'e consistin$ o *(re de%t than it is or the irst a"ternati'e consistin$ o %oth de%t and e.(it! %eca(se A. The di'ersit! o the co)%ination a"ternati'e creates $reater ris, or the in'estor. -. The *(re de%t a"ternati'e &o("d "ood the )ar,et and %e )ore di ic("t to se"". C. The *(re de%t a"ternati'e carries the ris, o increasin$ the *ro%a%i"it! o de a("t. D. The co)%ination a"ternati'e carries the ris, o increasin$ di'idend *a!)ents. I a W1A<<< %ond se""s or W1A1/@A &hich o the o""o&in$ state)ents are correct2 I. The )ar,et rate o interest is $reater than the co(*on rate on the %ond.
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Marginal ost of De-t ?/ . The )ar$ina" cost o U5ist -T. 8M9 CIA <@>4 IV14D A. -. C. D.
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. 0hich o the o""o&in$ state)ents is )ost correct2 8E9
3a$e 17 o @7
MANAGEMENT ADVISORY SERVICES a. I a co)*an!Cs tax rate increases %(t the !ie"d to )at(rit! o its nonca""a%"e %onds re)ains the sa)eA the co)*an!Cs )ar$ina" cost o de%t ca*ita" (sed to ca"c("ate its &ei$hted a'era$e cost o ca*ita" &i"" a"". %. A"" e"se e.(a"A an increase in a co)*an!Cs stoc, *rice &i"" increase the )ar$ina" cost o retained earnin$sA ,s. c. A"" e"se e.(a"A an increase in a co)*an!Cs stoc, *rice &i"" increase the )ar$ina" cost o iss(in$ ne& co))on e.(it!A ,e. d. State)ents a and % are correct. e. State)ents % and c are correct. -ri$ha) ost of De-t . ost of Preferre$ Stock 1?. The %asis or )eas(rin$ the cost o ca*ita" deri'ed ro) %onds and *re erred stoc,A res*ecti'e"!A is the 8M9 A. a ter1tax rate o interest or %onds and stated ann(a" di'idend rate or *re erred stoc, -. *retax rate o interest or %onds and stated ann(a" di'idend rate "ess the ex*ected earnin$s *er share or *re erred stoc, C. *retax rate o interest or %onds and stated ann(a" di'idend rate or *re erred stoc, D. a ter1tax rate o interest or %onds and stated ann(a" di'idend rate "ess the ex*ected earnin$s *er share or *re erred stoc, AIC3A ada*ted ost of De-t (s3 ost of E#uit! apital ?4 . In $enera"A it is )ore ex*ensi'e or a co)*an! to inance &ith e.(it! ca*ita" than &ith de%t ca*ita" %eca(se 8E9 A. 5on$1ter) %onds ha'e a )at(rit! date and )(st there ore %e re*aid in the (t(re. -. In'estors are ex*osed to $reater ris, &ith e.(it! ca*ita". C. E.(it! ca*ita" is in $reater de)and than de%t ca*ita". D. Di'idends "(ct(ate to a $reater extent than interest rates. CMA <=>< 111@ ost of E#uit! apital Cost o 3re erred Stoc, ?@ . 0hich o the o""o&in$ state)ents is )ost correct2 8M9 a. The %e ore1tax cost o *re erred stoc, )a! %e "o&er than the %e ore1tax cost o de%tA e'en tho($h *re erred stoc, is ris,ier than de%t. %. I a co)*an!Cs stoc, *rice increasesA this increases its cost o co))on e.(it!. c. I the cost o e.(it! ca*ita" is "o& eno($hA it )a! %e chea*er to iss(e co))on stoc, than it is to inance *ro+ects &ith retained earnin$s. d. State)ents a and % are correct. -ri$ha) R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
RISKS Cost o Co))on E.(it! . 0hich o the o""o&in$ actors in the disco(nted cash "o& 8DC:9 a**roach to esti)atin$ the cost o co))on e.(it! is the "east di ic("t to esti)ate2 8E9 a. Ex*ected $ro&th rateA $. c. Re.(ired ret(rnA ,s. s . %. Di'idend !ie"dA D1O3<. d. Ex*ected rate o ret(rnA k -ri$ha)
?=
. Ass()e that no)ina" interest rates +(st increased s(%stantia""! %(t that the ex*ected (t(re di'idends or a co)*an! o'er the "on$ r(n &ere not a ected. As a res("t o the increase in no)ina" interest ratesA the co)*an!Gs stoc, *rice sho("d A. Increase. C. Sta! constant. CIA <@>7 IV14> -. Decrease. D. Chan$eA %(t in no o%'io(s direction. . The )ar,et 'a"(e o a ir)Cs o(tstandin$ co))on shares &i"" %e hi$herA e'er!thin$ e"se e.(a"A i 8M9 a. In'estors ha'e a "o&er re.(ired ret(rn on e.(it!. %. In'estors ex*ect "o&er di'idend $ro&th. c. In'estors ha'e "on$er ex*ected ho"din$ *eriods. d. In'estors ha'e shorter ex*ected ho"din$ *eriods. CIA 11>= IV1/@
??
Cost o Retained Earnin$s ?D . 0hen ca"c("atin$ the cost o ca*ita"A the cost assi$ned to retained earnin$s sho("d %e 8E9 A. Lero. -. 5o&er than the cost o externa" co))on e.(it!. C. E.(a" to the cost o externa" co))on e.(it!. D. Bi$her than the cost o externa" co))on e.(it!. CIA 11>@ IV147
?>
. 0hich o the o""o&in$ state)ents is )ost correct2 8M9 a. The cost o retained earnin$s is the rate o ret(rn stoc,ho"ders re.(ire on a ir)Cs co))on stoc,. %. The co)*onent cost o *re erred stoc, is ex*ressed as , *81 1 T9A %eca(se *re erred stoc, di'idends are treated as ixed char$esA si)i"ar to the treat)ent o de%t interest. c. The %ond1!ie"d1*"(s1ris,1*re)i() a**roach to esti)atin$ a ir)Cs cost o co))on e.(it! in'o"'es addin$ a s(%+ecti'e"! deter)ined ris,1*re)i() to the )ar,et ris,1 ree %ond rate. d. The hi$her the ir)Cs "otation cost or ne& co))on stoc,A the )ore "i,e"! the ir) is to (se *re erred stoc,A &hich has no "otation cost. -ri$ha)
Marginal ost of apital D< . I a co)*an! has a hi$her di'idend1*a!o(t ratioA thenA i a"" e"se i e.(a"A it &i"" ha'e 3a$e 14 o @7
MANAGEMENT ADVISORY SERVICES a. %. c. d.

D1
RISKS C. Increases as the re.(ired rate o ret(rn increases D. -oth A and CIA <@>? IV1@7 Di'idend Gro&th Rate 14. Di'idend $ro&th rate or a sta%"e ir) can %e esti)ated as6 A. 3"o& %ac, rate I the ret(rn on e.(it! 8ROE9 -. 3"o& %ac, rate O the ret(rn on e.(it! 8ROE9 C. 3"o& %ac, rate Qthe ret(rn on e.(it! 8ROE9 D. 3"o& %ac, rate 1 the ret(rn on e.(it! 8ROE9 /4. The $ro&th rate in di'idends can %e tho($ht o as a s() o t&o *arts. The! are6 A. ROE and the Retention Ratio. -. Di'idend !ie"d and $ro&th rate in di'idends C. ROA and ROE D. -oo, 'a"(e *er share and E3S Di'idend Gro&th Mode" :or)("a 1/. The re.(ired rate o ret(rn on the )ar,et ca*ita"i#ation rate is esti)ated as o""o&s6 A. Di'idend !ie"d Q ex*ected rate o $ro&th in di'idends -. Di'idend !ie"d 1 ex*ected rate o $ro&th in di'idends C. Di'idend !ie"d O ex*ected rate o $ro&th in di'idends D. 8Di'idend !ie"D. I 8ex*ected rate o $ro&th in di'idends9 apital )sset Pricing Mo$el 4 )PM5 4>. The acron!) CA3M stands or6 A. Ca*ita" Asset 3ricin$ Mode" -. Certaint! Asset 3ricin$ Method
D@
A hi$her )ar$ina" cost o ca*ita". A "o&er )ar$ina" cost o ca*ita". A hi$her in'est)ent o**ort(nit! sched("e. A "o&er in'est)ent o**ort(nit! sched("e.
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. The ir)Cs )ar$ina" cost o ca*ita" 8E9 a. Sho("d %e the sa)e as the ir)Cs rate o ret(rn on e.(it!. %. Is (na ected %! the ir)Cs ca*ita" str(ct(re. CMA 1/>1 11D c. In in'erse"! re"ated to the ir)Cs re.(ired rate o ret(rn (sed in ca*ita" %(d$etin$. d. Is a &ei$hted1a'era$e o the in'estorsC re.(ired ret(rns on de%t and e.(it!.
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Di(i$en$ *rowth Mo$el D/ . 0hich o the o""o&in$ criteria theoretica""! sho("d %e (sed to deter)ine the 'a"(ation o co))on stoc,2 8E9 A. -oo, 'a"(e. C. -eta coe icient. -. Di'idends. D. Standard de'iation o ret(rns. G"ei)
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. 0hich o the o""o&in$ is direct"! a**"ied in deter)inin$ the 'a"(e o a stoc, &hen (sin$ the di'idend $ro&th )ode"2 A. The ir)Gs ca*ita" str(ct(re. -. The ir)Gs cash "o&s. C. The ir)Gs "i.(idit!. D. The in'estorGs re.(ired rate o ret(rn on the ir)Gs stoc,. CIA 11>< IV1@7 . The three e"e)ents needed to esti)ate the cost o e.(it! ca*ita" or (se in deter)inin$ a ir)Gs &ei$hted1a'era$e cost o ca*ita" are 8E9 A. C(rrent di'idends *er shareA ex*ected $ro&th rate in di'idends *er shareA and c(rrent %oo, 'a"(e *er share o co))on stoc,. -. C(rrent earnin$s *er shareA ex*ected $ro&th rate in di'idends *er shareA and c(rrent )ar,et *rice *er share o co))on stoc,. C. C(rrent earnin$s *ers shareA ex*ected $ro&th rate in earnin$s *er shareA and c(rrent %oo, 'a"(e *er share o co))on stoc,. D. C(rrent di'idends *er shareA ex*ected $ro&th rate in di'idends *er shareA and c(rrent )ar,et *rice *er share o co))on stoc,. CMA 1/>1 117
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D4
C. C(rrent Ar%itra$e 3ricin$ Method - & M D. C()("ati'e Ar%itra$e 3ricin$ Mode"
. The ca*ita" asset *ricin$ )ode" ass()es 8E9 a. a"" in'estors are *rice ta,ers. %. a"" in'estors ha'e the sa)e ho"din$ *eriod. c. in'estors *a! taxes on ca*ita" $ains. d. %oth a and - are tr(e. e. aA - and c are a"" tr(e.
-odie
/@. The 'a"(e o the stoc,6 A. Increases as the di'idend $ro&th rate increases -. Increases as the re.(ired rate o ret(rn decreases R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
77. I in'estors do not ,no& their in'est)ent hori#ons or certain 8M9 a. the CA3M is no "on$er 'a"id. %. the CA3M (nder"!in$ ass()*tions are not 'io"ated. 3a$e 1@ o @7
MANAGEMENT ADVISORY SERVICES c. the i)*"ications o the CA3M are not 'io"ated as "on$ as in'estorsC "i.(idit! needs re not *riced. d. the i)*"ications o the CA3M are no "on$er (se (". -odie 7?. The ca*ita" asset *ricin$ )ode" 8CA3M9 states that6 A. The ex*ected ris, *re)i() on an in'est)ent is *ro*ortiona" to its %eta -. The ex*ected rate o ret(rn on an in'est)ent is *ro*ortiona" to its %eta C. The ex*ected rate o ret(rn on an in'est)ent de*ends on the ris,1 ree rate and the )ar,et rate o ret(rn -&M D. The ex*ected rate o ret(rn on an in'est)ent is de*endent on the ris,1 ree rate @=. The dra&%ac, o the CA3M is that it6 A. I$nores the ret(rn on the )ar,et *ort o"io -. Re.(ired a sin$"e )eas(re o s!ste)atic ris, C. I$nores ris,1 ree ret(rn D. ;ti"i#es too )an! actors Sec(rit! Mar,et 5ine 4=. The sec(rit! )ar,et "ine 8SM59 sho&s the re"ationshi* %et&een. A. Ex*ected ret(rn and standard de'iation -. Ex*ected ret(rn and %eta C. Standard de'iation and ris, D. Variance and %eta 7D. The sec(rit! )ar,et "ine 8SM59 is the $ra*h o 6 A. Ex*ected rate on in'est)ent 8Y1axis9 's. 'ariance o ret(rn -. Ex*ected ret(rn on in'est)ent 's. standard de'iation o ret(rn C. Ex*ected rate o ret(rn on in'est)ent 's. %eta D. A and D= D?
RISKS . The sec(rit! )ar,et "ine 8SM59 8M9 a. can %e *ortra!ed $ra*hica""! as the ex*ected ret(rn1%eta re"ationshi*. %. can %e *ortra!ed $ra*hica""! as the ex*ected ret(rn1standard de'iation o )ar,et ret(rns re"ationshi*. c. *ro'ides a %ench)ar, or e'a"(ation o in'est)ent *er or)ance. d. a and c. e. - and c. -odie 0hich state)ent is not tr(e re$ardin$ the Ca*ita" Mar,et 5ine 8CM592 8M9 a. The CM5 is the "ine ro) the ris,1 ree rate thro($h the )ar,et *ort o"io. %. The CM5 is the %est attaina%"e ca*ita" a""ocation "ine. c. The CM5 is a"so ca""ed the sec(rit! )ar,et "ine. d. The CM5 a"&a!s has a *ositi'e s"o*e.
DD
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. In e.(i"i%ri()A the )ar$ina" *rice o ris, or a ris,! sec(rit! )(st %e 8M9 a. e.(a" to the )ar$ina" *rice o ris, or the )ar,et *ort o"io. %. $reater than the )ar$ina" *rice o ris, or the )ar,et *ort o"io. c. "ess than the )ar$ina" *rice o ris, or the )ar,et *ort o"io. d. ad+(sted %! its de$ree o nons!ste)atic ris,.
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. An (nder*riced sec(rit! &i"" *"ot 8E9 a. on the Sec(rit! Mar,et 5ine. %. %e"o& the Sec(rit! Mar,et 5ine. c. a%o'e the Sec(rit! Mar,et 5ine. -odie d. either a%o'e or %e"o& the Sec(rit! Mar,et 5ine de*endin$ on its co'ariance &ith the ar,et. e. either a%o'e or %e"o& the Sec(rit! Mar,et 5ine de*endin$ on its standard de'iation. C. -e"o& the sec(rit! )ar,et "ine D. On the Y1axis
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4?. I a stoc, is o'er*riced it &o("d *"ot6 A. A%o'e the sec(rit! )ar,et "ine -. On the sec(rit! )ar,et "ine
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The Sec(rit! Mar,et 5ine 8SM59 is 8M9 a. the "ine that descri%es the ex*ected ret(rn1%eta re"ationshi* or &e""1di'ersi ied *ort o"ios on"!. %. a"so ca""ed the Ca*ita" A""ocation 5ine. c. the "ine that is tan$ent to the e icient rontier o a"" ris,! assets. d. the "ine that re*resents the ex*ected ret(rn1%eta re"ationshi*. e. the "ine that re*resents the re"ationshi* %et&een an indi'id(a" sec(rit!Cs ret(rn and the )ar,etCs ret(rn. -odie
Varia%"es >1 . An ana"!sis o a co)*an!Cs *"anned e.(it! inancin$ (sin$ the ca*ita" asset *ricin$ )ode" 8or sec(rit! )ar,et "ine9 &o("d incor*orate on"! the a. Ex*ected )ar,et earnin$sA the c(rrent ;.S. Treas(r! %ond !ie"dA and the %eta coe icient. %. Ex*ected )ar,et earnin$s and the *rice1earnin$s ratio. c. C(rrent ;.S. Treas(r! %ond !ie"dA the *rice1earnin$s ratioA and the %eta coe icient. d. C(rrent ;.S. Treas(r! %ond !ie"d and the di'idend *a!o(t ratio. CMA 1/>1 111= 3a$e 1= o @7
MANAGEMENT ADVISORY SERVICES :or)("a >/ Accordin$ to the Ca*ita" Asset 3ricin$ Mode" 8CA3M9A the ex*ected rate o ret(rn on an! sec(rit! is e.(a" to 8M9 a. R Q ME8RM9N. c. R Q ME8RM 1 R N. %. R Q ME8RM9 1 R N. d. E8RM9 Q R . -odie Mar,et 3ort o"io >7 0hich state)ent is not tr(e re$ardin$ the )ar,et *ort o"io2 8M9 a. It inc"(des a"" assets o the (ni'erse. %. It "ies on the e icient rontier. c. A"" sec(rities in the )ar,et *ort o"io are he"d in *ro*ortion to their )ar,et 'a"(es. d. It is the tan$enc! *oint %et&een the ca*ita" )ar,et "ine and the indi erence c(r'e. A"*ha Coe icient >4 Accordin$ to the Ca*ita" Asset 3ricin$ Mode" 8CA3M9A air"! *riced sec(rities 8M9 a. ha'e *ositi'e %etas. c. ha'e ne$ati'e %etas. %. ha'e #ero a"*has. d. ha'e *ositi'e a"*has.
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RISKS D. Variance o the ret(rn on the )ar,et x Variance o the ret(rn on the sec(rit! X Co'ariance o the ret(rns on the )ar,et and on the sec(rit!. G"ei)
>D
. Accordin$ to the ca*ita" asset *ricin$ )ode" 8CA3M9A the re"e'ant ris, o a sec(rit! is its A. Co)*an!1s*eci ic ris,. C. S!ste)atic ris,. -. Di'ersi ia%"e ris,. D. Tota" ris,. CIA 11>4 IV1@7
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7>. -eta )eas(res6 A. The a%i"it! to di'ersi ! ris, -. The chan$e in the rate o ret(rn o an in'est)ent or a $i'en chan$e in the )ar,et rate o ret(rn C. The act(a" ret(rn on an asset D. A and C -&M 4<. -eta )eas(re indicates6 A. The a%i"it! to di'ersi ! ris, -. The chan$e in the rate o ret(rn on an in'est)ent or a $i'en chan$e in the )ar,et ret(rn C. The act(a" ret(rn on an asset D. A and C -&M
>>
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. Accordin$ to the Ca*ita" Asset 3ricin$ Mode" 8CA3M9A 8M9 a. a sec(rit! &ith a *ositi'e a"*ha is considered o'er*riced. %. a sec(rit! &ith a #ero a"*ha is considered to %e a $ood %(!. c. a sec(rit! &ith a ne$ati'e a"*ha is considered to %e a $ood %(!. d. a sec(rit! &ith a *ositi'e a"*ha is consider to %e (nder*riced.
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-eta Coe icient >= . A )eas(re that descri%es the ris, o an in'est)ent *ro+ect re"ati'e to other in'est)ents in $enera" is the 8E9 A. Coe icient o 'ariation. C. Standard de'iation. -. -eta coe icient. D. Ex*ected ret(rn. CIA 11D? IV1==
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The )ar,et ris,A %etaA o a sec(rit! is e.(a" to 8M9 a. the co'ariance %et&een the sec(rit!Cs ret(rn and the )ar,et ret(rn di'ided %! the 'ariance o the )ar,etGs ret(rns. %. the co'ariance %et&een the sec(rit! and )ar,et ret(rns di'ided %! the standard de'iation o the )ar,etGs ret(rns. c. the 'ariance o the sec(rit!Gs ret(rns di'ided %! the co'ariance %et&een the sec(rit! and )ar,et ret(rns. -odie d. the 'ariance o the sec(rit!Gs ret(rns di'ided %! the 'ariance o the )ar,etGs ret(rns. The )ar,et *ort o"io has a %eta o 8E9 a. <. %. 1. c. 11. d. <.@.
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. 0hat is the or)("a or the %eta coe icient o a sec(rit!2 A. Co'ariance o the ret(rns on the )ar,et and on the sec(rit! X Variance o the ret(rn on the )ar,et. -. Co'ariance o the ret(rns on the )ar,et and on the sec(rit! x Variance o the ret(rn on the )ar,et. C. Variance o the ret(rn on the )ar,et X Variance o the ret(rn on the sec(rit!.
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I the ir) is %ein$ o*erated so as to )axi)i#e shareho"der &ea"thA and i o(r %asic ass()*tions concernin$ the re"ationshi* %et&een ris, and ret(rn are tr(eA then &hich o the o""o&in$ sho("d %e tr(e2 8M9 a. I the %eta o the asset is "ar$er than the ir)Cs %etaA then the re.(ired ret(rn on the asset is "ess than the re.(ired ret(rn on the ir). 3a$e 1? o @7
MANAGEMENT ADVISORY SERVICES %. I the %eta o the asset is s)a""er than the ir)Cs %etaA then the re.(ired ret(rn on the asset is $reater than the re.(ired ret(rn on the ir). c. I the %eta o the asset is $reater than the ir)Cs %eta *rior to the addition o that assetA then the ir)Cs %eta a ter the *(rchase o the asset &i"" %e s)a""er than the ori$ina" ir)Cs %eta. d. I the %eta o an asset is "ar$er than the ir)Cs %eta *rior to the addition o that assetA then the re.(ired ret(rn on the ir) &i"" %e $reater a ter the *(rchase o that asset than *rior to its *(rchase. -ri$ha) . 0hich o the o""o&in$ state)ents is )ost correct2 8M9 a. -eta )eas(res )ar,et ris,A %(t i a ir)Cs stoc,ho"ders are not &e"" di'ersi iedA %eta )a! not acc(rate"! )eas(re stand1a"one ris,. %. I the ca"c("ated %eta (nderesti)ates the ir)Cs tr(e in'est)ent ris,A then the CA3M )ethod &i"" o'eresti)ate ,s. c. The disco(nted cash "o& )ethod o esti)atin$ the cost o e.(it! canCt %e (sed (n"ess the $ro&th co)*onentA $A is constant d(rin$ the ana"!sis *eriod. -ri$ha) d. An ad'anta$e shared %! %oth the DC: and CA3M )ethods o esti)atin$ the cost o e.(it! ca*ita"A is that the! !ie"d *recise esti)ates and re.(ire "itt"e or no +(d$e)ent. 0hich o the o""o&in$ state)ents is correct2 8M9 a. The cost o ca*ita" (sed to e'a"(ate a *ro+ect sho("d %e the cost o the s*eci ic t!*e o inancin$ (sed to (nd that *ro+ect. %. The cost o de%t (sed to ca"c("ate the &ei$hted a'era$e cost o ca*ita" is %ased on an a'era$e o the cost o de%t a"read! iss(ed %! the ir) and the cost o ne& de%t. c. One *ro%"e) &ith the CA3M a**roach to esti)atin$ the cost o e.(it! ca*ita" is that i a ir)Cs stoc,ho"ders areA in actA not &e"" di'ersi iedA %eta )a! %e a *oor )eas(re o the ir)Cs tr(e in'est)ent ris,. d. The %ond1!ie"d1*"(s1ris,1*re)i() a**roach is the )ost so*histicated and o%+ecti'e )ethod o esti)atin$ a ir)Cs cost o e.(it! ca*ita". e. The cost o e.(it! ca*ita" is $enera""! easier to )eas(re than the cost o de%tA &hich 'aries dai"! &ith interest ratesA or the cost o *re erred stoc, since *re erred stoc, is iss(ed in re.(ent"!. -ri$ha) . In the context o the Ca*ita" Asset 3ricin$ Mode" 8CA3M9 the re"e'ant )eas(re o ris, is 8E9 a. (ni.(e ris,. c. standard de'iation o ret(rns. %. %eta. d. 'ariance o ret(rns. -odie A. -. C. D. Increase /<J aster than the )ar,et in (* )ar,ets Increase /<J aster than the )ar,et in do&n )ar,ets Increase 1/<J aster than the )ar,et in (* )ar,ets Increase 1/<J aster than the )ar,et in do&n )ar,ets
RISKS
-&M
Ris,1 ree Rate 1</ . 0hat is the ex*ected ret(rn o a #ero1%eta sec(rit!2 8M9 a. The )ar,et rate o ret(rn. c. A ne$ati'e rate o ret(rn. %. Lero rate o ret(rn. d. The ris,1 ree rate.
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Ris, 3re)i() 1<7 . Accordin$ to the CA3MA the ris, *re)i() an in'estor ex*ects to recei'e on an! stoc, or *ort o"io increases6 8E9 a. direct"! &ith a"*ha. d. in'erse"! &ith %eta. %. in'erse"! &ith a"*ha. e. in *ro*ortion to its standard de'iation. c. direct"! &ith %eta. -odie
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. The ris, *re)i() on the )ar,et *ort o"io &i"" %e *ro*ortiona" to 8M9 a. the a'era$e de$ree o ris, a'ersion o the in'estor *o*("ation. %. the ris, o the )ar,et *ort o"io as )eas(red %! its 'ariance. c. the ris, o the )ar,et *ort o"io as )eas(red %! its %eta. d. %oth a and - are tr(e. e. %oth a and c are tr(e.
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7=. The )ar,et ris, *re)i() is6 A. The di erence %et&een the rate o ret(rn on an asset and the ris,1 ree rate -. The di erence %et&een the rate o ret(rn on the )ar,et *ort o"io and the ris,1 ree rate C. The ris,1 ree rate D. The )ar,et rate o ret(rn -&M 3(re 3"a! Method . 0hich o the o""o&in$ )ethods in'o"'es ca"c("atin$ an a'era$e %eta or ir)s in a si)i"ar %(siness and then a**"!in$ that %eta to deter)ine a *ro+ectCs %eta2 8M9 a. Ris, *re)i() )ethod. c. Acco(ntin$ %eta )ethod. %. 3(re *"a! )ethod. d. CA3M )ethod. -ri$ha)
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4@. A stoc, &ith a %eta o 1./ &o("d %e ex*ected to6 R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
. Interstate Trans*ort has a tar$et ca*ita" str(ct(re o @< *ercent de%t and @< *ercent co))on e.(it!. The ir) is considerin$ a ne& inde*endent *ro+ect that has an ex*ected ret(rn o 17 3a$e 1D o @7
MANAGEMENT ADVISORY SERVICES *ercent and is not re"ated to trans*ortation. Bo&e'erA a *(re *"a! *rox! ir) has %een identi ied that is exc"(si'e"! en$a$ed in the ne& "ine o %(siness. The *rox! ir) has a %eta o 1.7D. -oth ir)s ha'e a )ar$ina" tax rate o 4< *ercentA and InterstateCs %e ore1tax cost o de%t is 1/ *ercent. The ris,1 ree rate is 1< *ercent and the )ar,et ris, *re)i() is @ *ercent. The ir) sho("d8M9 a. Re+ect the *ro+ectK its ex*ected ret(rn is "ess than the ir)Cs re.(ired rate o ret(rn on the *ro+ect o 1=.> *ercent. %. Acce*t the *ro+ectK its ex*ected ret(rn is $reater than the ir)Cs re.(ired rate o ret(rn on the *ro+ect o 1/.<@ *ercent. c. Re+ect the *ro+ectK its ex*ected ret(rn is on"! 17 *ercent. d. Acce*t the *ro+ectK its ex*ected ret(rn exceeds the ris,1 ree rate and the %e ore1tax cost o de%t. e. -e indi erent %et&een acce*tin$ or re+ectin$K the ir)Cs re.(ired rate o ret(rn on the *ro+ect e.(a"s its ex*ected ret(rn. -ri$ha) Re.(ired Rate o Ret(rn 1<= . I the ret(rn on the )ar,et *ort o"io is 1<J and the ris,1 ree rate is @JA &hat is the e ect on a co)*an!Gs re.(ired rate o ret(rn on its stoc, o an increase in the %eta coe icient ro) 1./ to 1.@2 A. 7J increase C. No chan$e -. 1.@J increase D. 1.@J decrease G"ei) Ex*ected Rate o Ret(rn 's. Re.(ired Rate o Ret(rn 1<? . Sec(rit! E has an ex*ected rate o ret(rn o <.11 and a %eta o 1.@. The ris,1 ree rate is <.<@ and the )ar,et ex*ected rate o ret(rn is <.<>. Accordin$ to the Ca*ita" Asset 3ricin$ Mode"A this sec(rit! is 8M9 a. (nder*riced. %. o'er*riced. c. air"! *riced. d. cannot %e deter)ined ro) data *ro'ided. -odie
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RISKS . Gi'en the o""o&in$ t&o stoc,s A and Ex*ected rate o ret(rn -eta A <.1/ 1./ <.14 1.D I the ex*ected )ar,et rate o ret(rn is <.<> and the ris,1 ree rate is <.<@A &hich sec(rit! &o("d %e considered the %etter %(! and &h!2 8M9 a. A %eca(se it o ers an ex*ected excess ret(rn o 1./J. %. - %eca(se it o ers an ex*ected excess ret(rn o 1.DJ. c. A %eca(se it o ers an ex*ected excess ret(rn o /./J. d. - %eca(se it o ers an ex*ected ret(rn o 14J. e. - %eca(se it has a hi$her %eta. -odie
6eighte$-)(erage ost of apital 46) 5 1. The cost o ca*ita" is de ined as 8E9 a. the si)*"e a'era$e o the interest rates o a"" de%t o(tstandin$. %. the si)*"e a'era$e o the cost o de%t and e.(it!. c. the &ei$hted a'era$e o the interest rates o a"" de%t o(tstandin$. d. the &ei$hted a'era$e o the cost o de%t and e.(it!. .
SA S & S
0hich o the o""o&in$ is not considered a ca*ita" co)*onent or the *(r*ose o ca"c("atin$ the &ei$hted a'era$e cost o ca*ita" as it a**"ies to ca*ita" %(d$etin$2 8E9 a. 5on$1ter) de%t. c. Short1ter) de%t. %. Co))on stoc,. d. 3re erred stoc,. -ri$ha)
/D. The co)%ined &ei$hted a'era$e interest rate that a ir) inc(rs on its "on$1ter) de%tA *re erred stoc,A and co))on stoc, is the a. cost o ca*ita". c. c(to rate. %. disco(nt rate. d. interna" rate o ret(rn. -ar ie"d 1<D.The &ei$hted a'era$e cost o ca*ita" re*resents the a. cost o %ondsA *re erred stoc,A and co))on stoc, di'ided %! the three so(rces. %. e.(i'a"ent (nits o ca*ita" (sed %! the or$ani#ation. c. o'era"" cost o ca*ita" ro) a"" or$ani#ation inancin$ so(rces. d. o'era"" cost o di'idends *"(s interest *aid %! the or$ani#ation.
. The ris,1 ree rate is ? *ercent. The ex*ected )ar,et rate o ret(rn is 1@ *ercent. I !o( ex*ect stoc, E &ith a %eta o 1.7 to o er a rate o ret(rn o 1/ *ercentA !o( sho("d 8M9 a. %(! stoc, E %eca(se it is o'er*riced. %. se"" short stoc, E %eca(se it is o'er*riced. c. se"" stoc, short E %eca(se it is (nder*riced. d. %(! stoc, E %eca(se it is (nder*riced. -odie
-ar ie"d
/>. The &ei$hted a'era$e cost o ca*ita" that is (sed to e'a"(ate a s*eci ic *ro+ect sho("d %e %ased on the a. )ix o ca*ita" co)*onents that &as (sed to inance a *ro+ect ro) "ast !ear. 3a$e 1> o @7
MANAGEMENT ADVISORY SERVICES %. o'era"" ca*ita" str(ct(re o the cor*oration. c. cost o ca*ita" or other cor*orations &ith si)i"ar in'est)ents. d. )ix o ca*ita" co)*onents or a"" ca*ita" ac.(ired in the )ost recent isca" !ear.
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RISKS 1D. The &ei$hted1a'era$e cost o ca*ita" a**roach to decision )a,in$ is not direct"! a ected %! the6 8E9 A. *ro*osed )ix o de%tA e.(it!A and existin$ (nds (sed to i)*"e)ent the *ro+ect -. 'a"(e o the co))on stoc, C. cost o de%t o(tstandin$ D. c(rrent %(d$et or ex*ansion AIC3A ada*ted 7<. De%t in the ca*ita" str(ct(re co("d %e treated as i it &ere co))on e.(it! in co)*(tin$ the &ei$hted a'era$e cost o ca*ita" i the de%t &ere a. ca""a%"e. c. c()("ati'e. %. *artici*atin$. d. con'erti%"e. -ar ie"d . :or a t!*ica" ir) &ith a $i'en ca*ita" str(ct(reA &hich o the o""o&in$ is correct2 8Note6 A"" rates are a ter taxes.9 8E9 a. ,d T ,e T ,s T 0ACC. c. 0ACC T ,e T ,s T ,d. %. ,s T ,e T ,d T 0ACC. d. ,e T ,s T 0ACC T ,d. -ri$ha) C. rE U rA U rD D. None o the a%o'e are tr(e
-ar ie"d
. 0hich o the o""o&in$ state)ents is correct2 8M9 a. -eca(se &e o ten need to )a,e co)*arisons a)on$ ir)s that are in di erent inco)e tax %rac,etsA it is %est to ca"c("ate the 0ACC on a %e ore1tax %asis. %. I a ir) has %een s( erin$ acco(ntin$ "osses and is ex*ected to contin(e s( erin$ s(ch "ossesA and there ore its tax rate is #eroA it is *ossi%"e that its a ter1tax co)*onent cost o *re erred stoc, as (sed to ca"c("ate the 0ACC &i"" %e "ess than its a ter1tax co)*onent cost o de%t. c. Nor)a""!A the cost o externa" e.(it! raised %! iss(in$ ne& co))on stoc, is a%o'e the cost o retained earnin$s. Moreo'erA the hi$her the $ro&th rate is re"ati'e to the di'idend !ie"dA the )ore the cost o externa" e.(it! &i"" exceed the cost o retained earnin$s. d. The "o&er a co)*an!Cs tax rateA the $reater the ad'anta$e o (sin$ de%t in ter)s o "o&erin$ its 0ACC. -ri$ha) . 0hen ca"c("atin$ a ir)Gs cost o ca*ita"A a"" o the o""o&in$ are tr(e exce*t that 8E9 A. The cost o ca*ita" o a ir) is the &ei$hted a'era$e cost o its 'ario(s inancin$ co)*onents. -. The ca"c("ation o the cost o ca*ita" sho("d oc(s on the historica" costs o a"ternati'e or)s o inancin$ rather than )ar,et or c(rrent costs. C. A"" costs sho("d %e ex*ressed as a ter1tax costs. D. The ti)e 'a"(e o )one! sho("d %e incor*orated into the ca"c("ations. CMA 1/DD 11/ . A co)*an! has )ade the decision to inance next !earGs ca*ita" *ro+ects thro($h de%t rather than additiona" e.(it!. The %ench)ar, cost o ca*ita" or these *ro+ects sho("d %e 8M9 A. The %e ore1tax cost o ne&1de%t inancin$. -. The a ter1tax cost o ne&1de%t inancin$. C. The cost o e.(it! inancin$. D. The &ei$hted1a'era$e cost o ca*ita". CIA <@>? IV14/ . 0hich o the o""o&in$ is tr(e re$ardin$ the ca"c("ation o a ir)Gs cost o ca*ita"2 8E9 A. The cost o ca*ita" o a ir) is the &ei$hted1a'era$e cost o its 'ario(s inancin$ co)*onents. -. A"" costs sho("d %e ex*ressed as *re1tax costs. C. The ti)e 'a"(e o )one! sho("d %e exc"(ded ro) the ca"c("ations. D. The cost o ca*ita" is the cost o e.(it!. CMA 1/DD 11/
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77. 0hich o the o""o&in$ is tr(e2 A. rD U rA U rE -. rE U rD U rA 71. Genera""!A &hich o the o""o&in$ is tr(e2 A. rD T rA T rE -. rE T rD T rA
114
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11/
C. rE T rA T rD D. None o the a%o'e are tr(e
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117
. 0hich o the o""o&in$ state)ents is correct2 8M9 a. The 0ACC sho("d inc"(de on"! a ter1tax co)*onent costs. There oreA the re.(ired rates o ret(rn 8or Y)ar,et ratesZ9 on de%tA *re erredA and co))on e.(it! 8,dA ,*A and ,s9 )(st %e ad+(sted to an a ter1tax %asis %e ore the! are (sed in the 0ACC e.(ation. -ri$ha) %. The cost o retained earnin$s is $enera""! hi$her than the cost o ne& co))on stoc,. c. 3re erred stoc, is ris,ier to in'estors than is de%t. There oreA i so)eone to"d !o( that the )ar,et rates sho&ed ,d T ,* or a $i'en co)*an!A that *erson )(st ha'e )ade a )ista,e. d. I a co)*an! &ith a de%t ratio o @< *ercent &ere s(dden"! exe)*ted ro) a"" (t(re inco)e taxesA thenA a"" other thin$s he"d constantA this &o("d ca(se its 0ACC to increase. . 0hich o the o""o&in$ state)ents is )ost correct2 8M9 3a$e /< o @7
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MANAGEMENT ADVISORY SERVICES a. The &ei$hted a'era$e cost o ca*ita" or a $i'en ca*ita" %(d$et "e'e" is a &ei$hted a'era$e o the )ar$ina" cost o each re"e'ant ca*ita" co)*onent that )a,es (* the ir)Cs tar$et ca*ita" str(ct(re. %. The &ei$hted a'era$e cost o ca*ita" is ca"c("ated on a %e ore1tax %asis. c. An increase in the ris,1 ree rate is "i,e"! to increase the )ar$ina" costs o %oth de%t and e.(it! inancin$. d. State)ents a and c are correct. -ri$ha)
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RISKS c. The cost o retained earnin$s is $enera""! )ore ex*ensi'e than the cost o iss(in$ ne& co))on stoc,A %eca(se it inc"(des an o**ort(nit! cost. d. State)ents a and % are correct. e. A"" o the state)ents a%o'e are correct. -ri$ha)
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. A co)*an! has a ca*ita" str(ct(re that consists o @< *ercent de%t and @< *ercent e.(it!. 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. The cost o e.(it! inancin$ is $reater than or e.(a" to the cost o de%t inancin$. %. The 0ACC exceeds the cost o e.(it! inancin$. c. The 0ACC is ca"c("ated on a %e ore1tax %asis. d. The 0ACC re*resents the cost o ca*ita" %ased on historica" a'era$es. In that senseA it does not re*resent the )ar$ina" cost o ca*ita". e. The cost o retained earnin$s exceeds the cost o iss(in$ ne& co))on stoc,. -ri$ha) . 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. The 0ACC is a )eas(re o the %e ore1tax cost o ca*ita". %. T!*ica""! the a ter1tax cost o de%t inancin$ exceeds the a ter1tax cost o e.(it! inancin$. c. The 0ACC )eas(res the )ar$ina" a ter1tax cost o ca*ita". d. State)ents a and % are correct. e. State)ents % and c are correct. -ri$ha) . Ca)*%e"" Co. is tr!in$ to esti)ate its &ei$hted a'era$e cost o ca*ita" 80ACC9. 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. The a ter1tax cost o de%t is $enera""! chea*er than the a ter1tax cost o *re erred stoc,. %. Since retained earnin$s are readi"! a'ai"a%"eA the cost o retained earnin$s is $enera""! "o&er than the cost o de%t. c. I the co)*an!Cs %eta increasesA this &i"" increase the cost o e.(it! inancin$A e'en i the co)*an! is a%"e to re"! on on"! retained earnin$s or its e.(it! inancin$. d. State)ents a and % are correct. e. State)ents a and c are correct. -ri$ha) . 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. The 0ACC re*resents the a ter1tax cost o ca*ita". %. The 0ACC re*resents the )ar$ina" cost o ca*ita".
. 0hich o the o""o&in$ state)ents a%o(t the cost o ca*ita" is incorrect2 8E9 a. A co)*an!Cs tar$et ca*ita" str(ct(re a ects its &ei$hted a'era$e cost o ca*ita". %. 0ei$hted a'era$e cost o ca*ita" ca"c("ations sho("d %e %ased on the a ter1tax costs o a"" the indi'id(a" ca*ita" co)*onents. c. I a co)*an!Cs tax rate increasesA thenA a"" e"se e.(a"A its &ei$hted a'era$e cost o ca*ita" &i"" increase. d. :"otation costs can increase the &ei$hted a'era$e cost o ca*ita". e. An increase in the ris,1 ree rate is "i,e"! to increase the )ar$ina" costs o %oth de%t and e.(it! inancin$. -ri$ha) A co)*an! esti)ates that an a'era$e1ris, *ro+ect has a 0ACC o 1< *ercentA a %e"o&1 a'era$e ris, *ro+ect has a 0ACC o D *ercentA and an a%o'e1a'era$e ris, *ro+ect has a 0ACC o 1/ *ercent. 0hich o the o""o&in$ inde*endent *ro+ects sho("d the co)*an! acce*t2 8E9 a. 3ro+ect A has a'era$e ris, and a ret(rn o > *ercent. %. 3ro+ect - has %e"o&1a'era$e ris, and a ret(rn o D.@ *ercent. c. 3ro+ect C has a%o'e1a'era$e ris, and a ret(rn o 11 *ercent. d. A"" o the *ro+ects a%o'e sho("d %e acce*ted. e. None o the *ro+ects a%o'e sho("d %e acce*ted. -ri$ha)
11?
11D
//. 0hich o the o""o&in$ re$ardin$ the &ei$hted1a'era$e cost o ca*ita" is tr(e2 a. The tax e ect o *re erred stoc, di'idends sho("d %e inc"(ded in the ca"c("ation o &ei$hted1a'era$e cost o ca*ita". %. The tax e ect o co))on stoc, di'idends sho("d %e inc"(ded in the ca"c("ation o &ei$hted1a'era$e cost o ca*ita". c. The tax e ect o de%t sho("d %e inc"(ded in the ca"c("ation o the &ei$hted1a'era$e cost o ca*ita". d. Taxes do not a ect the &ei$hted1a'era$e cost o ca*ita". SA S & S /7. 0hich o the o""o&in$ is tr(e re$ardin$ the &ei$hted1a'era$e cost o ca*ita"2 a. A co)*an! )a! ha'e t&o &ei$hted1a'era$e costs o ca*ita" i the ir)Gs ca*ita" str(ct(re is so "ar$e that ne& co))on stoc, )(st %e so"d. 3a$e /1 o @7
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MANAGEMENT ADVISORY SERVICES %. The %oo, 'a"(e o the co)*onents o ca*ita" sho("d a"&a!s %e (sed to ca"c("ate the &ei$hted1a'era$e cost o ca*ita". c. The cost o co))on e.(it! is "o&er than the cost o retained earnin$s. d. The cost o *re erred stoc, is ad+(sted or the tax ded(ction associated &ith *re erred di'idends. SA S & S 0ACC in a Tax1:ree En'iron)ent /1. The cost o ca*ita" or a ir)A r0ACCA in a tax ree en'iron)ent is6 A. E.(a" to the ex*ected E-IT di'ided %! )ar,et 'a"(e o the (n"e'ered ir) -. E.(a" to rAA the rate o ret(rn or that %(siness ris, c"ass C. E.(a" to the o'era"" rate o ret(rn re.(ired on the "e'ered ir) D. A"" o the a%o'e
RISKS is not re"ated to trans*ortation. Bo&e'erA a *(re *"a! *rox! ir) has %een identi ied that is exc"(si'e"! en$a$ed in the ne& "ine o %(siness. The *rox! ir) has a %eta o 1.7D. -oth ir)s ha'e a )ar$ina" tax rate o 4< *ercentA and InterstateCs %e ore1tax cost o de%t is 1/ *ercent. The ris,1 ree rate is 1< *ercent and the )ar,et ris, *re)i() is @ *ercent. The ir) sho("d8M9 a. Re+ect the *ro+ectK its ret(rn is "ess than the ir)Cs re.(ired rate o ret(rn on the *ro+ect o 1=.> *ercent. %. Acce*t the *ro+ectK its ret(rn is $reater than the ir)Cs re.(ired rate o ret(rn on the *ro+ect o 1/.<@ *ercent. c. Re+ect the *ro+ectK its ret(rn is on"! 17 *ercent. d. Acce*t the *ro+ectK its ret(rn exceeds the ris,1 ree rate and the %e ore1tax cost o de%t. e. -e indi erent %et&een acce*tin$ or re+ectin$K the ir)Cs re.(ired rate o ret(rn on the *ro+ect e.(a"s its ex*ected ret(rn. -ri$ha) ,ptimal Pro7ect Selection 1/4 . [ac,son Cor*oration is e'a"(atin$ the o""o&in$ o(r inde*endentA in'est)ent o**ort(nities6 3ro+ect Cost Ex*ected Rate o Ret(rn A W7<<A<<< 14J 1@<A<<< 1< C /<<A<<< 17 D 4<<A<<< 11 [ac,sonCs tar$et ca*ita" str(ct(re is =< *ercent de%t and 4< *ercent e.(it!. The !ie"d to )at(rit! on the co)*an!Cs de%t is 1< *ercent. [ac,son &i"" inc(r "otation costs or a ne& e.(it! iss(ance o 1/ *ercent. The $ro&th rate is a constant = *ercent. The stoc, *rice is c(rrent"! W7@ *er share or each o the 1<A<<< shares o(tstandin$. Ass()e that the ir) has no retained earnin$s. I the co)*an!Cs tax rate is 7< *ercentA then &hich o the *ro+ects &i"" %e acce*ted2 8M9 a. 3ro+ect A. c. 3ro+ects AA CA and D. -ri$ha) %. 3ro+ects A and C. d. A"" o the in'est)ent *ro+ects &i"" %e ta,en. Sensiti(it! )nal!sis Ris,A Re.(ired Ret(rn and *ro+ect %etas . I the ir) is %ein$ o*erated so as to )axi)i#e shareho"der &ea"thA and i o(r %asic ass()*tions concernin$ the re"ationshi* %et&een ris, and ret(rn are tr(eA then &hich o the o""o&in$ sho("d %e tr(e2 8M9 a. I the %eta o the asset is "ar$er than the ir)Cs %etaA then the re.(ired ret(rn on the asset is "ess than the re.(ired ret(rn on the ir). %. I the %eta o the asset is s)a""er than the ir)Cs %etaA then the re.(ired ret(rn on the asset is $reater than the re.(ired ret(rn on the ir). 3a$e // o @7
-&M
Ca*ita" Asset 3ricin$ Mode" 1/1 . 0!den -rothers has no retained earnin$s. The co)*an! (ses the CA3M to ca"c("ate the cost o e.(it! ca*ita". The co)*an!Cs ca*ita" str(ct(re consists o co))on stoc,A *re erred stoc,A and de%t. 0hich o the o""o&in$ e'ents &i"" red(ce the co)*an!Cs 0ACC2 8M9 a. A red(ction in the )ar,et ris, *re)i(). %. An increase in the "otation costs associated &ith iss(in$ ne& co))on stoc,. c. An increase in the co)*an!Cs %eta. d. An increase in ex*ected in "ation. e. An increase in the "otation costs associated &ith iss(in$ *re erred stoc,. -ri$ha) Re#uire$ Rate of Return 1// . 5o(isiana Enter*risesA an a""1e.(it! ir)A is considerin$ a ne& ca*ita" in'est)ent. Ana"!sis has indicated that the *ro*osed in'est)ent has a %eta o <.@ and &i"" $enerate an ex*ected ret(rn o ? *ercent. The ir) c(rrent"! has a re.(ired ret(rn o 1<.?@ *ercent and a %eta o 1./@. The in'est)entA i (nderta,enA &i"" do(%"e the ir)Cs tota" assets. I ,R: is ? *ercent and the )ar,et ret(rn is 1< *ercentA sho("d the ir) (nderta,e the in'est)ent2 8Choose the %est ans&er.9 8D9 a. YesK the ex*ected ret(rn o the asset 8?J9 exceeds the re.(ired ret(rn 8=.@J9. %. YesK the %eta o the asset &i"" red(ce the ris, o the ir). c. NoK the ex*ected ret(rn o the asset 8?J9 is "ess than the re.(ired ret(rn 8D.@J9. d. NoK the ris, o the asset 8%eta9 &i"" increase the ir)Cs %eta. e. NoK the ex*ected ret(rn o the asset is "ess than the ir)Cs re.(ired ret(rnA &hich is 1<.?@J. -ri$ha) . Interstate Trans*ort has a tar$et ca*ita" str(ct(re o @< *ercent de%t and @< *ercent co))on e.(it!. The ir) is considerin$ a ne& inde*endent *ro+ect that has a ret(rn o 17 *ercent and R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
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MANAGEMENT ADVISORY SERVICES c. I the %eta o the asset is $reater than the cor*orate %eta *rior to the addition o that assetA then the cor*orate %eta a ter the *(rchase o the asset &i"" %e s)a""er than the ori$ina" cor*orate %eta. d. I the %eta o an asset is "ar$er than the cor*orate %eta *rior to the addition o that assetA then the re.(ired ret(rn on the ir) &i"" %e $reater a ter the *(rchase o that asset than *rior to its *(rchase. -ri$ha) -eta and *ro+ect ris, . 0hich o the o""o&in$ state)ents is correct2 8D9 a. A re"ati'e"! ris,! (t(re cash o(t "o& sho("d %e e'a"(ated (sin$ a re"ati'e"! "o& disco(nt rate. %. I a ir)Cs )ana$ers &ant to )axi)i#e the 'a"(e o the stoc,A the! sho("d concentrate exc"(si'e"! on *ro+ectsC )ar,etA or %etaA ris,. c. I a ir) e'a"(ates a"" *ro+ects (sin$ the sa)e cost o ca*ita"A then the ris,iness o the ir) as )eas(red %! its %eta &i"" *ro%a%"! dec"ine o'er ti)e. d. I a ir) has a %eta that is "ess than 1.<A sa! <.>A this &o("d s($$est that its assetsC ret(rns are ne$ati'e"! corre"ated &ith the ret(rns o )ost other ir)sC assets. -ri$ha) . omprehensi(e 0hich o the o""o&in$ state)ents is correct2 8M9 a. A"tho($h so)e )ethods o esti)atin$ the cost o e.(it! ca*ita" enco(nter se'ere di ic("tiesA the CA3M is a si)*"e and re"ia%"e )ode" that *ro'ides $reat acc(rac! and consistenc! in esti)atin$ the cost o e.(it! ca*ita". %. The DC: )ode" is *re erred o'er other )ode"s to esti)ate the cost o e.(it! %eca(se o the ease &ith &hich a ir)Cs $ro&th rate is o%tained. c. The %ond1!ie"d1*"(s1ris,1*re)i() a**roach to esti)atin$ the cost o e.(it! is not a"&a!s acc(rate %(t its ad'anta$es are that it is a standardi#ed and o%+ecti'e )ode". d. De*reciation1$enerated (nds are an additiona" so(rce o ca*ita" andA in actA re*resent the "ar$est sin$"e so(rce o (nds or so)e ir)s. -ri$ha)
RISKS c. Mana$ers o ten ha'e a res*onsi%i"it! to *ro'ide contin(o(s ser'iceK the! )(st *reser'e the "on$1r(n 'ia%i"it! o the enter*rise. Th(sA the $oa" o e)*"o!in$ "e'era$e to )axi)i#e short1r(n stoc, *rice and )ini)i#e ca*ita" cost )a! con "ict &ith "on$1r(n 'ia%i"it!. d. A"" o the state)ents a%o'e are correct. e. None o the state)ents a%o'e re*resents a serio(s i)*edi)ent to the *ractica" a**"ication o "e'era$e ana"!sis in ca*ita" str(ct(re deter)ination. -ri$ha) ,perating "e(erage 1/@ . 0hich c"ass o "e'era$e ca(ses earnin$s %e ore interest and taxes to %e )ore sensiti'e to chan$es in sa"es2 8M9 A. Credit. C. O*eratin$. -. :inancia". D. Intrinsic. CIA <@>7 IV1@?
"EVER)*E "imits of le(erage /1. 0hich o the o""o&in$ are *ractica" di ic("ties associated &ith ca*ita" str(ct(re and de$ree o "e'era$e ana"!ses2 8M9 a. It is near"! i)*ossi%"e to deter)ine exact"! ho& 3OE ratios or e.(it! ca*ita"i#ation rates 8, s 'a"(es9 are a ected %! di erent de$rees o inancia" "e'era$e. %. Mana$ersC attit(des to&ard ris, di er and so)e )ana$ers )a! set a tar$et ca*ita" str(ct(re other than the one that &o("d )axi)i#e stoc, *rice. R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS 3a$e /7 o @7

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RISKS a. Tradin$ in the stoc, o other co)*anies %. Retirin$ %onds %e ore )at(rit! c. ;sin$ (nds *ro'ided %! creditors d. 3(rchasin$ and se""in$ treas(r! stoc,s
. The *ercenta$e chan$e in earnin$s %e ore interest and taxes associated &ith the *ercenta$e chan$e in sa"es 'o"()e re*resents the de$ree o 8E9 A. O*eratin$ "e'era$e. C. -rea,e'en "e'era$e. -. :inancia" "e'era$e. D. Co)%ined "e'era$e. CIA 11D> IV1@4 . The de$ree o o*eratin$ "e'era$e 8DO59 is A. Constant at a"" "e'e"s o sa"es. -. A )eas(re o the chan$e in earnin$s a'ai"a%"e to co))on stoc,ho"ders associated &ith a $i'en chan$e in o*eratin$ earnin$s. C. A )eas(re o the chan$e in o*eratin$ inco)e res("tin$ ro) a $i'en chan$e in sa"es. D. 5o&er i the de$ree o tota" "e'era$e is hi$herA other thin$s he"d constant. CIA <@>4 IV1@/ . Co)*anies ex*erience chan$es in interest ex*ensesA 'aria%"e cost *er (nitA .(antit! o (nits so"dA and ixed costs. Their de$ree o o*eratin$ "e'era$e is not a ected %! the chan$e in A. Interest ex*enses. C. F(antit! o (nits so"d. -. Varia%"e cost *er (nit. D. :ixed costs. CIA 11>7 IV1@7 . A ir) &ith a hi$her de$ree o o*eratin$ "e'era$e &hen co)*ared to the ind(str! a'era$e i)*"ies that the A. :ir) has hi$her 'aria%"e costs. -. :ir)Gs *ro its are )ore sensiti'e to chan$es in sa"es 'o"()e. C. :ir) is )ore *ro ita%"e. D. :ir) is "ess ris,!. CMA <=>@ 111
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1/D
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&inancial "e(erage I. Sec(rin$ the (nds or in'est)ent at a ixed rate o ret(rn to (nd s(**"iersA to enhance the &e""1%ein$ o the co))on stoc,ho"ders is ,no&n as a. :inancia" "e'era$e. c. 3r(dent %orro&in$. %. :(nd )ana$e)ent. d. :inancia" ar%itra$e. R3C3A 1<>? I. It re ers to the *ractice o inancin$ assets &ith %orro&ed ca*ita". Its extensi'e (se )a! i)*act on the ret(rn on co))on stoc,ho"dersC e.(it! to %e a%o'e or %e"o& the rate o ret(rn on tota" assets. a. Disco(ntin$. c. 5e'era$e. %. Mort$a$e. d. Ar%itra$e. R3C3A <@>? YTradin$ on e.(it!Z *ertains to the *ractice o 8E9 R3C3A 1<??A <@DD 3a$e /4 o @7
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MANAGEMENT ADVISORY SERVICES I. This acco(ntin$ ter)ino"o$! has re erence to "on$1ter) de%t and )eans that !o( %orro& so)e%od!Cs )one! at an interest rate &hich is "o&er than the rate &hich !o( can earn on that )one!. a. 3oo"in$ o interest. c. Kitin$. %. 5e'era$e or tradin$ on e.(it!. d. None o the a%o'e. R3C3A 1<D4 I.
RISKS The (se o %orro&ed ca*ita" %! %(siness ir)s is re erred to as "e'era$e or tradin$ on e.(it!. This "e'era$e is "i,e"! to %e a so(nd inancia" strate$! or stoc,ho"ders o co)*anies ha'in$ a. C!c"ica" hi$h and "o& a)o(nts o re*orted earnin$s. %. Stead! a)o(nts o re*orted earnin$s. c. Vo"ati"e "(ct(ation in re*orted earnin$s o'er short *eriods o ti)e. d. Steadi"! dec"inin$ a)o(nts o re*orted earnin$s. R3C3A 1<?> . The *(rchase o treas(r! stoc, &ith a ir)Gs s(r*"(s cash CMA 1/>1 11@ A. Increases a ir)Gs assets. C. Increases a ir)Gs interest co'era$e ratio. -. Increases a ir)Gs inancia" "e'era$e. D. Di"(tes a ir)Gs earnin$s *er share. . 0hen a co)*an! increases its de$ree o inancia" "e'era$e 8D:59 a. The e.(it! %eta o the co)*an! a""s. %. The s!ste)atic ris, o the co)*an! a""s. c. The s!ste)atic ris, o the co)*an! rises. d. The standard de'iation o ret(rns on the e.(it! o the co)*an! rises.
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CIA <@>? IV1@<
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. S!"'an Cor*oration has the o""o&in$ ca*ita" str(ct(re. De%ent(re %onds W1<A<<<A<<< 3re erred e.(it! 1A<<<A<<< Co))on e.(it! 7>A<<<A<<< The inancia" "e'era$e o S!"'an Cor*oration &o("d increase as a res("t o 8M9 A. Iss(in$ co))on stoc, and (sin$ the *roceeds to retire *re erred stoc,. -. Maintainin$ the sa)e do""ar "e'e" o cash di'idends as the *rior !earA e'en tho($h earnin$s ha'e increased %! ?J. C. :inancin$ its (t(re in'est)ents &ith a hi$her *ercenta$e o %onds. D. :inancin$ its (t(re in'est)ents &ith a hi$her *ercenta$e o e.(it! (nds. CMA <=>< 11> . E'er!thin$ e"se %ein$ e.(a"A a U5ist AT hi$h"! "e'era$ed ir) &i"" ha'e U5ist -T earnin$s *er share. 8D9 CIA <@>@ IV1@1 A. -. C. D. 5ist A More More 5ess 5ess 5ist 5o&er 5ess 'o"ati"e 5ess 'o"ati"e Bi$her . A co)*an! is considerin$ the ear"! retire)ent o its 1<JA 1<1!ear %onds *a!a%"e. -e ore retirin$ the %ondsA the co)*an!Gs ca*ita" str(ct(re &as C(rrent "ia%i"ities W1/@A<<< 3a$e /@ o @7
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MANAGEMENT ADVISORY SERVICES 5on$1ter) "ia%i"ities6 Notes *a!a%"e 8d(e in @ !ears9 -onds *a!a%"e 3re)i() on %onds *a!a%"e O&nerGs e.(it!6 Co))on shares 8W@ *ar 'a"(e9 Share *re)i() in excess o *ar Retained earnin$s I the %onds can %e retired at 1<7.@JA the A. De%t1e.(it! ratio &i"" increase. -. :inancia" "e'era$e &i"" decrease.
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RISKS /<<A<<< 7<<A<<< /@A<<< 1@<A<<< @<A<<< 4@<A<<< CIA 11>7 IV14D C. Asset t(rno'er ratio &i"" decrease. D. Ret(rn on o&nerGs e.(it! &i"" decrease. . Co)*an! A and Co)*an! - ha'e the sa)e tax rateA the sa)e tota" assetsA and the sa)e %asic earnin$ *o&er. -oth co)*anies ha'e a %asic earnin$ *o&er that exceeds their %e ore1 tax costs o de%tA ,d. Bo&e'erA Co)*an! A has a hi$her de%t ratio and hi$her interest ex*ense than Co)*an! -. 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. Co)*an! A has a "o&er net inco)e than -. %. Co)*an! A has a "o&er ROA than -. c. Co)*an! A has a "o&er ROE than -. d. State)ents a and % are correct. -ri$ha) . :ir) ; and :ir) 5 each ha'e the sa)e tota" assets. -oth ir)s a"so ha'e a %asic earnin$ *o&er o /< *ercent. :ir) ; is 1<< *ercent e.(it! inancedA &hi"e :ir) 5 is inanced &ith @< *ercent de%t and @< *ercent e.(it!. :ir) 5Cs de%t has a %e ore1tax cost o D *ercent. -oth ir)s ha'e *ositi'e net inco)e. 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. The t&o co)*anies ha'e the sa)e ti)es interest earned 8TIE9 ratio. %. :ir) 5 has a "o&er ROA. c. :ir) 5 has a "o&er ROE. d. State)ents a and % are correct. e. State)ents % and c are correct. -ri$ha)
17D
&inancial le(erage an$ EPS 17@ . Vo"$a 3(%"ishin$ is considerin$ a *ro*osed increase in its de%t ratioA &hich &i"" a"so increase the co)*an!Cs interest ex*ense. The *"an &o("d in'o"'e the co)*an! iss(in$ ne& %onds and (sin$ the *roceeds to %(! %ac, shares o its co))on stoc,. The co)*an!Cs C:O ex*ects that the *"an &i"" not chan$e the co)*an!Cs tota" assets or o*eratin$ inco)e. Bo&e'erA the co)*an!Cs C:O does esti)ate that it &i"" increase the co)*an!Cs earnin$s *er share 8E3S9. Ass()in$ the C:OCs esti)ates are correctA &hich o the o""o&in$ state)ents is )ost correct2 8E9 a. Since the *ro*osed *"an increases Vo"$aCs inancia" ris,A the co)*an!Cs stoc, *rice sti"" )i$ht a"" e'en tho($h its E3S is ex*ected to increase. %. I the *"an red(ces the co)*an!Cs 0ACCA the co)*an!Cs stoc, *rice is a"so "i,e"! to dec"ine. c. Since the *"an is ex*ected to increase E3SA this i)*"ies that net inco)e is a"so ex*ected to increase. d. State)ents a and % are correct. e. State)ents a and c are correct. -ri$ha)
17=
&inancial le(erage an$ ratios 17> . Co)*an! A and Co)*an! - ha'e the sa)e tota" assetsA o*eratin$ inco)e 8E-IT9A tax rateA and %(siness ris,. Co)*an! AA ho&e'erA has a )(ch hi$her de%t ratio than Co)*an! -. Co)*an! ACs %asic earnin$ *o&er 8-E39 exceeds its cost o de%t inancin$ 8,d9. 0hich o the o""o&in$ state)ents is )ost correct2 8M9 a. Co)*an! A has a hi$her ret(rn on assets 8ROA9 than Co)*an! -. %. Co)*an! A has a hi$her ti)es interest earned 8TIE9 ratio than Co)*an! -. c. Co)*an! A has a hi$her ret(rn on e.(it! 8ROE9 than Co)*an! -A and its ris,A as )eas(red %! the standard de'iation o ROEA is a"so hi$her than Co)*an! -Cs. d. State)ents % and c are correct. -ri$ha) ,perating an$ &inancial "e(erage /<. 0hich o the o""o&in$ state)ents is )ost correct2 8M9 a. :ir)s &hose sa"es are 'er! sensiti'e to chan$es in the %(siness c!c"e are )ore "i,e"! to re"! on de%t inancin$. %. :ir)s &ith "ar$e tax "oss carr! or&ards are )ore "i,e"! to re"! on de%t inancin$. c. :ir)s &ith a hi$h o*eratin$ "e'era$e are )ore "i,e"! to re"! on de%t inancin$. d. State)ents a and c are correct. e. None o the state)ents a%o'e is correct. -ri$ha) 3a$e /= o @7
. 0hich o the o""o&in$ state)ents is )ost correct2 8E9 a. Increasin$ inancia" "e'era$e is one &a! to increase a ir)Cs %asic earnin$ *o&er 8-E39. %. :ir)s &ith "o&er ixed costs tend to ha'e $reater o*eratin$ "e'era$e. c. The de%t ratio that )axi)i#es E3S $enera""! exceeds the de%t ratio &hich )axi)i#es share *rice. d. State)ents a and % are correct. e. State)ents a and c are correct. -ri$ha)
&inancial le(erage an$ ratios R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
MANAGEMENT ADVISORY SERVICES -. Endo&)ent. omprehensi(e 14< . 0hich o the chan$es in "e'era$e &o("d a**"! to a co)*an! that s(%stantia""! increases its in'est)ent in ixed assets as a *ro*ortion o tota" assets and re*"aces so)e o its "on$1ter) de%t &ith e.(it!2 8M9 CIA <@>< IV1@= A. -. C. D. :inancia" 5e'era$e Increase Decrease Increase Decrease O*eratin$ 5e'era$e Decrease Increase Increase Decrease INS2R)N E 141 . Ins(rance )a! %est %e de ined as A. A s!ste) or trans errin$ ris, thro($h ris, a'oidance or "oss contro". -. An! contract that con'e!s an ins(ra%"e interest. C. A or) o *(re ris, ca""ed $a)%"in$. G"ei) D. A )eans o co)%inin$ )an! "oss ex*os(res so that "osses are shared %! a"" *artici*ants.
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RISKS D. Ter). G"ei)
. [on -erstoc, is an e)*"o!ee o 3RA Inc. D(rin$ his e)*"o!)entA the cor*orationGs earnin$s ha'e do(%"edA "ar$e"! %eca(se o [onGs a%i"it! to attract ne& acco(nts. 3R there ore ins(red his "i e or a s(%stantia" s(). I [on diesA &i"" 3R %e a%"e to co""ect the ins(rance *roceeds2 A. YesA %eca(se a cor*oration has an ins(ra%"e interest in a"" its e)*"o!ees since it can act on"! thro($h a$ents. -. YesA %eca(se 3R has a *ec(niar! interest in [onGs contin(ed "i e. C. NoA %eca(se 3R &i"" contin(e to exist a ter [onGs death. D. NoA %eca(se [on &as not a stoc,ho"der or o icer o 3RA Inc. G"ei) . 0hich o the o""o&in$ is a characteristic o ire ins(rance2 A. It is )ore standardi#ed than "i e ins(rance. -. It is &ritten or a re"ati'e"! short *eriod %(t (s(a""! inc"(des an incontesta%i"it! c"a(se. C. A *o"ic! )(st %e 'a"(ed and contain a *ro rata c"a(se. D. The ins(ra%"e interest )(st %e an o&nershi* interest in the *ro*ert! itse" . G"ei)
14?
. 0hich o the o""o&in$ is the %est (nctiona" de inition o ins(rance2 A. A "e$a" contract %! &hich the ins(rerA in ret(rn or considerationA a$rees to *a! another *erson i a stated "oss or in+(r! occ(rs. -. A "e$a" contract %! &hich an ins(rance co)*an!A in ret(rn or *re)i()sA a$rees to *a! the *o"ic!ho"der i a certain e'ent occ(rs. C. A &ritten *ro)ise %! the ins(rer to *a! the %ene iciar! i "oss occ(rs ro) the occ(rrence o a contin$ent e'ent. D. A &ritin$ iss(ed %! an ins(rance co)*an!A or a considerationA that *ro)ises to inde)ni ! a %ene iciar! or a "oss ro) an existin$ ris, or one &hich arises "ater. G"ei) . In &hich &a! does the or)ation o an ins(rance contract di er ro) an! other contract2 A. The re.(ire)ent that the ins(red )(st ha'e an ins(ra%"e interest. -. The ins(rance contract is not 'a"id (n"ess &ritten. C. Consideration is not needed or the or)ation o an ins(rance contract. D. In ins(ranceA on"! the ins(red can co))it a %reach. G"ei) . 5i e ins(rance A. Is a contract o inde)nit!. -. ;s(a""! has short1ter) *o"icies. C. Co'ers on"! the )orta"it! ris,. D. Genera""! has no cash 'a"(e.
147
144
G"ei)
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. 5i e ins(rance is o ered in se'era" or)s. The ,ind that o ers no in'est)ent eat(re is A. 0ho"e "i e. C. Strai$ht "i e. R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS
3a$e /? o @7

14D
RISKS -. [e&e"r!A Inc. &i"" reco'er W/A<<<A the "oss "ess the a)o(nt in excess o the W1<A<<< dis*"a! "i)itation. C. [e&e"r!A Inc. &i"" reco'er the ("" W4A<<< since the &arrant! &i"" %e constr(ed as a )ere re*resentation. D. [e&e"r!A Inc. &i"" reco'er the ("" W4A<<< since attachin$ the a**"ication to the *o"ic! is ins( icient to )a,e it a *art thereo . AIC3A 11D1 51@@
. The t!*ica" "i e ins(rance *o"ic! contains A. No exc"(sion or death d(rin$ )i"itar! ser'ice. -. A c"a(se a""o&in$ co'era$e or death d(rin$ nonco))ercia" "i$ht. C. A *rohi%ition on reinstate)ent. D. A *ro'ision or a $race *eriod or *re)i() *a!)ent. . A ire ins(rance *o"ic! ordinari"! inde)ni ies or "osses arisin$ ro) A. :riend"!A %(t not hosti"eA ires. -. Bosti"eA %(t not riend"!A ires. C. -oth hosti"e and riend"! ires. D. S)o,e *rod(ced %! riend"! or hosti"e ires.
G"ei)
14>
G"ei)
1@<
. 0hich o the o""o&in$ &ron$ (" acts *re'ents reco'er! (nder a *o"ic! o ire ins(rance2 A. Arson %! the ins(redGs e)*"o!ees or a$ents. -. Arson %! third *ersons (nre"ated to the ins(red. C. An act %! the ins(red intended to ca(se the da)a$e. D. Gross ne$"i$ence %(t not a)o(ntin$ to rec,"essness and &i"" (" )iscond(ct. G"ei) . 0hich o the o""o&in$ is not a t!*e o ins(rance *o"ic! that *ro'ides "ia%i"it! co'era$e2 A. Ma"*ractice ins(rance. C. A(to)o%i"e ins(rance. -. Bo)eo&ners ins(rance. D. :ire ins(rance. G"ei) . The *(r*ose o a co1ins(rance c"a(se is to A. Enco(ra$e *o"ic!ho"ders to %ear a *ro*ortionate *art o an! "oss. -. Enco(ra$e ins(rers to *a! the ace a)o(nt o the *o"ic! in the e'ent o a *artia" "oss on the *art o the ins(red. C. Enco(ra$e *o"ic!ho"ders to ins(re co))ercia" *ro*ert! or an a)o(nt that is near to its ("" re*"ace)ent cost. D. Enco(ra$e *o"ic!ho"ders to ins(re co))ercia" *ro*ert! or an a)o(nt that is si$ni icant"! "ess than its ("" re*"ace)ent cost. G"ei) . [e&e"r!A Inc. too, o(t an ins(rance *o"ic! &ith Ins(rance Co)*an! &hich co'ered the stoc, o +e&e"r!. Ins(rance a$reed to inde)ni ! or "osses d(e to the t o the +e&e"s dis*"a!ed. The a**"ication contained the o""o&in$ *ro'ision6 PIt is here%! &arranted that the )axi)() 'a"(e o the +e&e"r! dis*"a!ed sha"" not exceed W1<A<<<.P The ins(rance *o"ic!Gs co'era$e &as or WDA<<<. S(%se.(ent"!A thie'es s)ashed the store &indo& and sto"e W4A<<< &orth o +e&e"s &hen the tota" 'a"(e o the dis*"a! &as W1/A<<<. 0hich o the o""o&in$ is correct2 A. [e&e"r!A Inc. &i"" reco'er nothin$. 3a$e /D o @7
1@1
1@/
1@7
RISKS
3a$e /> o @7
MANAGEMENT ADVISORY SERVICES )NS6ER E8P")N)TI,NS In(estment Risk &inancial Risk ,ptimal apital Structure ost of apital De%t Ca*ita" 's. E.(it! Ca*ita" I)*(ted Costs 's. Ex*"icit Costs Cost o De%t Ca*ita" Mar$ina" Cost o De%t Cost o E.(it! Ca*ita" Mar$ina" Cost o Ca*ita" O*ti)a" Cost o Ca*ita" Di'idend Gro&th Mode" Ca*ita" Asset 3ricin$ Mode" 8CA3M9 "e(erage Pro-a-ilit! . Statistics
RISKS
3a$e 7< o @7
. Ans&er 8A9 is correct. In'est)ent ris, is ana"!#ed in ter)s o the *ro%a%i"it! that the act(a" ret(rn on an in'est)ent &i"" %e "o&er than the ex*ected ret(rn. Co)*arin$ a *ro+ectGs ex*ected ret(rn to the ret(rn on an asset o si)i"ar ris,A he"*s deter)ine &hether the *ro+ect is &orth in'estin$ in. I the ex*ected ret(rn on a *ro+ect exceeds the ret(rn on an asset o co)*ara%"e ris,A then the *ro+ect sho("d %e *(rs(ed. Ans&er 8-9 is incorrect %eca(se a *ro+ect sho("d %e *(rs(ed on"! i its ex*ected ret(rn exceeds the ret(rn on in'est)ents o si)i"ar ris,. Ans&er 8C9 is incorrect %eca(se a *ro+ect sho("d %e *(rs(ed on"! i its ex*ected ret(rn exceeds the ret(rn on in'est)ents o si)i"ar ris,. Ans&er 8D9 is incorrect %eca(se a *ro+ect sho("d %e *(rs(ed on"! i its ex*ected ret(rn exceeds the ret(rn on in'est)ents o si)i"ar ris,. . Ans&er 8D9 is correct. Interest1rate ris, is the ris, o "(ct(ations in the 'a"(e o an asset d(e to chan$es in interest rates. One co)*onent o interest1rate ris, is *rice ris,A &hich is *ortra!ed as a dec"ine in the 'a"(e o %onds as interest rates increase. Rein'est)ent1rate ris, is another co)*onent o interest1rate ris,. I interest rates dec"ineA "o&er ret(rns &i"" %e a'ai"a%"e or rein'est)ent o interest and *rinci*a" *a!)ents recei'ed. Ans&er 8A9 is incorrect %eca(se *(rchasin$1*o&er ris, concerns in "ationA and de a("t ris, concerns non*a!)ent %! the de%tor. Ans&er 8-9 is incorrect %eca(se )ar,et ris, concerns *rice chan$es in the o'era"" sec(rities )ar,ets. Ans&er 8C9 is incorrect %eca(se *ort o"io ris, is the ris, re)ainin$ in a *ort o"io a ter di'ersi !in$ in'est)ents. . REF;IRED6 The )ar,eta%"e sec(rities &ith the "east de a("t ris,. DISC;SSION6 8-9 The )ar,eta%"e sec(rities &ith the "o&est de a("t ris, are those iss(ed %! the edera" $o'ern)ent %eca(se the! are %ac,ed %! the ("" aith and credit o the ;.S. $o'ern)ent an are there ore the "east ris,! or) o in'est)ent. Ans&er 8A9 is incorrect %eca(se sec(rities iss(ed %! a edera" a$enc! are irst %ac,ed %! that a$enc! and secondari"! %! the ;.S. $o'ern)ent. A$enc! sec(rities are iss(ed %! a$encies and cor*orations created %! the edera" $o'ern)entA s(ch as the :edera" Bo(sin$ Ad)inistration. Ans&er 8C9 is incorrect %eca(se re*(rchase a$ree)ents co("d %eco)e &orth"ess i the or$ani#ation a$reein$ to )a,e the re*(rchase $oes %an,r(*t. Ans&er 8D9 is incorrect %eca(se co))ercia" *a*er is (nsec(red. . Ans&er 8-9 is correct. 3rices o a"" stoc,sA e'en the 'a"(e o *ort o"iosA are corre"ated to so)e de$ree &ith %road s&in$s in the stoc, )ar,et. Mar,et ris, is the ris, that chan$es in a stoc,Gs *rice &i"" res("t ro) chan$es in the stoc, )ar,et as a &ho"e. Mar,et ris, is co))on"! re erred to as nondi'ersi ia%"e ris,. Ans&er 8A9 is incorrect %eca(se *(rchasin$1*o&er ris, is the ris, that a $enera" rise in the *rice "e'e" &i"" red(ce the .(antit! o $oods that can %e *(rchased &ith a ixed s() o )one!. Ans&er 8C9 is incorrect %eca(se non)ar,et ris, is the ris, that is in "(enced %! an indi'id(a" ir)Gs *o"icies and decisions. Non)ar,et ris, is di'ersi ia%"e %eca(se it is s*eci ic to each ir). Ans&er 8D9 is incorrect %eca(se interest1rate ris, is the ris, that the 'a"(e o an asset &i"" "(ct(ate d(e to chan$es in the interest rate. . Ans&er 8D9 is correct. Nons!ste)atic ris, is considered to %e (ni.(e to a ir) and there ore rando). In ca*ita" )ar,et theor!A nons!ste)atic ris, can "ar$e"! %e a'oided thro($h di'ersi ied in'est)ents. Ans&ers 8A9 and 8-9 are incorrect %eca(se nons!ste)atic ris, cannot %e corre"ated &ith an! 'aria%"eA &hether .(a"itati'e or .(antitati'e. Ans&er 8C9 is incorrect %eca(se )a! %e red(ced thro($h di'ersi ication.
6 7
. .
Corporate risk Corporate risk
Answer: b Diff: E Answer: e Diff: M
. Ans&er 8-9 is correct. Tota" ris, is the ris, o a sin$"e assetA &hereas )ar,et ris, is its ris, i it is he"d in a "ar$e *ort o"io o di'ersi ied sec(rities. Tota" ris, there ore inc"(des di'ersi ia%"e and (ndi'ersi ia%"e ris,. Ans&er 8A9 is incorrect %eca(se non)ar,et ris, is di'ersi ia%"e and (ndi'ersi ia%"e ris,. Ans&er 8C9 is incorrect %eca(se *ort o"io ris, is di'ersi ia%"e and (ndi'ersi ia%"e ris,. Ans&er 8D9 is incorrect %eca(se )ar,et ris, is di'ersi ia%"e and (ndi'ersi ia%"e ris,. . Ans&er 8D9 is correct. The $reater the standard de'iation o ret(rnsA the $reater the ris, is or an asset. The ex*ected ret(rn can 'ar! an!&here %et&een the "ar$e standard de'iation o ret(rnsA creatin$ the ris, that the act(a" ret(rn is si$ni icant"! "o& in the ran$e o the standard de'iation o ret(rns.
Ans&er 8A9 is incorrect %eca(se an asset &ith hi$h ris, &i"" ha'e a hi$h ex*ected ret(rn to co)*ensate or the additiona" ris,. Ans&er 8-9 is incorrect %eca(se an asset &ith hi$h ris, &i"" ha'e a hi$her *rice than an asset &ith "o& ris, d(e to the hi$h ex*ected ret(rn. Ans&er 8C9 is incorrect %eca(se an asset &ith hi$h ris, &i"" ha'e a constant ex*ected ret(rnA not an increasin$ ex*ected ret(rn.
10
. REF;IRED6 The circ()stance in &hich o'era"" co)*an! ris, &i"" %e "o&est. DISC;SSION6 8A9 A co))on $enera" de inition is that ris, is an in'est)ent &ith an (n,no&n o(tco)e %(t a ,no&n *ro%a%i"it! distri%(tion o ret(rns 8a ,no&n )ean and standard de'iation9. An increase in the standard de'iation 8'aria%i"it!9 o ret(rns is s!non!)o(s &ith an increase in the ris,iness o a *ro+ect. Ris, is a"so increased &hen the *ro+ectCs ret(rns are *ositi'e"! 8direct"!9 corre"ated &ith other in'est)ents in the ir)Cs *ort o"ioA i.eA ris, increases &hen ret(rns on a"" *ro+ects rise or a"" to$ether. Conse.(ent"!A the o'era"" ris, is decreased &ith *ro+ects ha'e "o& 'aria%i"it! and are ne$ati'e"! corre"ated 8the di'ersi ication e ect9. Ans&ers 8-9A 8C9A and 8D9 are incorrect %eca(se o'era"" ris, is decreased &hen *ro+ects ha'e "o& 'aria%i"it! and are ne$ati'e"! corre"ated. . Ans&er 8D9 is correct. An asset is "i.(id i it can %e con'erted to cash on short notice. 5i.(idit! 8)ar,eta%i"it!9 ris, is the ris, that assets cannot %e so"d at a reasona%"e *rice on short notice. I an asset is not "i.(idA in'estors &i"" re.(ire a hi$her ret(rn than or a "i.(id asset. The di erence is the "i.(idit! *re)i(). Ans&er 8A9 is incorrect %eca(se de a("t ris, is the ris, that a %orro&er &i"" not *a! the interest or *rinci*a" on a "oan. Ans&er 8-9 is incorrect %eca(se interest1rate ris, is the ris, to &hich in'estors are ex*osed %eca(se o chan$in$ interest rates. Ans&er 8C9 is incorrect %eca(se *(rchasin$1*o&er ris, is the ris, that in "ation &i"" red(ce the *(rchasin$ *o&er o a $i'en s() o )one!. . Ans&er 8D9 is correct. 5i.(idit! ris, is the *ossi%i"it! that an asset cannot %e so"d on short notice or its )ar,et 'a"(e. I an asset )(st %e so"d at a hi$h disco(ntA it is said to ha'e a s(%stantia" a)o(nt o "i.(idit! ris,. Ans&er 8A9 is incorrect %eca(se interest rate ris, is ca(sed %! "(ct(ations in the 'a"(e o an asset as interest rates chan$e. Its co)*onents are *rice ris, and rein'est)ent1rate ris,. Ans&er 8-9 is incorrect %eca(se *(rchasin$ *o&er ris, is the ris, that a $enera" rise in the *rice "e'e" 8in "ation9 &i"" red(ce &hat can %e *(rchased &ith a ixed s() o )one!. Ans&er 8C9 is incorrect %eca(se inancia" ris, is the ris, %orne %! shareho"dersA in excess o %asic %(siness ris,A that arises ro) (se o inancia" "e'era$e 8iss(ance o ixed inco)e sec(ritiesA i.e.A de%t and *re erred stoc,. . Ans&er 8A9 is correct. -(siness ris, is the ris, o "(ct(ations in earnin$s %e ore interest and taxes or in o*eratin$ inco)e &hen the ir) (ses no de%t. It de*ends on actors s(ch as de)and 'aria%i"it!A sa"es *rice 'aria%i"it!A in*(t *rice 'aria%i"it!A and the a)o(nt o o*eratin$ "e'era$e. :inancia" "e'era$e a ects inancia" ris, and is not a actor a ectin$ %(siness ris,. Ans&er 8-9 is incorrect %eca(se sa"es *rice 'aria%i"it! is a actor a ectin$ %(siness ris,. Ans&er 8C9 is incorrect %eca(se de)and 'aria%i"it! is a actor a ectin$ %(siness ris,. Ans&er 8D9 is incorrect %eca(se in*(t *rice 'aria%i"it! is a actor a ectin$ %(siness ris,. . Ans&er 8A9 is correct. -(siness ris, is the ris, o "(ct(ations in earnin$s %e ore interest and taxes or in o*eratin$ inco)e &hen the ir) (ses no de%t. It is the ris, inherent in its o*erations that exc"(des inancia" ris,A &hich is the ris, to the shareho"ders ro) the (se o inancia" "e'era$e. -(siness ris, de*ends on actors s(ch as de)and 'aria%i"it!A sa"es *rice 'aria%i"it!A in*(t *rice 'aria%i"it!A and a)o(nt o o*eratin$ "e'era$e. Ans&er 8-9 is incorrect %eca(se %(siness ris, de*ends on s(ch actors as a)o(nt o o*eratin$ "e'era$e. Ans&er 8C9 is incorrect %eca(se %(siness ris, de*ends on s(ch actors as de)and 'aria%i"it!. Ans&er 8D9 is incorrect %eca(se %(siness ris, de*ends on s(ch actors as "(ct(ations in s(**"iersG *rices. . State)ents a and % are correctK there oreA state)ent d is the correct choice. Bi$h (ncertaint! a%o(t (t(re sa"es i)*"ies hi$h %(siness ris,. The extent to &hich a ir)Cs costs are ixed a ects %(siness ris,. :inancia" "e'era$e does not a ect the ir)Cs %(siness ris,. :inancia" "e'era$e shi ts the %(siness ris, %et&een c"asses o o&nershi*A that isA de%t and e.(it!. . REF;IRED6 The set o ratios that characteri#es the ir) &ith the $reatest inancia" ris,.
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12
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DISC;SSION6 8C9 A ir) &ith hi$h ris, &i"" ha'e a hi$her de%t1to1e.(it! ratio than a "o& ris, ir)A a "o&er interest co'era$eA and a 'o"ati"e ret(rn on e.(it!. A hi$her de%t1to1e.(it! ratio *oses a $reater ris, o inso"'enc!. De%tho"ders )(st %e *aid re$ard"ess o &hether the ir) is *ro ita%"e. 5o& interest co'era$e )eans that the )ar$in o sa et! o earnin$s %e ore interest and taxes is s)a"". A 'o"ati"e ret(rn on e.(it! si$ni ies that earnin$s are (n*redicta%"e. 5ac, o *redicta%i"it! increases ris,. Ans&er 8A9 are incorrect %eca(se hi$h interest co'era$e s($$ests "o&er ris,. Ans&er 8-9 is incorrect %eca(se a "o& de%t1to1e.(it! ratio indicates a "o& "e'e" o ris,. Ans&er 8D9 is incorrect %eca(se a "o& de%t1to1e.(it! ratioA hi$h interest co'era$eA and a sta%"e ret(rn on e.(it! s($$ests "o&er ris,.
17
. Ans&er 8D9 is correct. 0hen a)o(nts to %e *aid or recei'ed are deno)inated in a orei$n c(rrenc!A exchan$e rate "(ct(ations )a! res("t in exchan$e $ains or "osses. :or exa)*"eA i a ;.S. ir) has a recei'a%"e ixed in ter)s o (nits o a orei$n c(rrenc!A a dec"ine in the 'a"(e o that c(rrenc! re"ati'e to the ;.S. do""ar res("ts in a orei$n exchan$e "oss. Ans&er 8A9 is incorrect %eca(se so'erei$n or ex*ro*riation ris, is the ris, that the so'erei$n co(ntr! in &hich the assets %ac,in$ an in'est)ent are "ocated &i"" sei#e the assets &itho(t ade.(ate co)*ensation. Ans&er 8-9 is incorrect %eca(se so'erei$n or ex*ro*riation ris, is the ris, that the so'erei$n co(ntr! in &hich the assets %ac,in$ an in'est)ent are "ocated &i"" sei#e the assets &itho(t ade.(ate co)*ensation. Ans&er 8C9 is incorrect %eca(se the %eta 'a"(e in the ca*ita" asset *ricin$ )ode" or a )("tinationa" ir) is the s!ste)atic ris, o a $i'en )("tinationa" ir) re"ati'e to that o the )ar,et as a &ho"e. . Ans&er 8C9 is correct. Exchan$e1rate ris, is the ris, that a orei$n c(rrenc! transaction &i"" %e ne$ati'e"! ex*osed to "(ct(ations in exchan$e rates. -eca(se O & - Co)*an! se""s $oods to Ger)an c(sto)ers and records acco(nts recei'a%"e deno)inated in de(tsche )ar,sA O & - Co)*an! is ex*osed to exchan$e1rate ris,. Ans&er 8A9 is incorrect %eca(se "i.(idit! ris, is the *ossi%i"it! that an asset cannot %e so"d on short notice or its )ar,et 'a"(e. Ans&er 8-9 is incorrect %eca(se %(siness ris, is the ris, o "(ct(ations in earnin$s %e ore interest and taxes or in o*eratin$ inco)e &hen the ir) (ses no de%t. Ans&er 8D9 is incorrect %eca(se *rice ris, is a co)*onent o interest1rate ris,. . Ans&er 8A9 is correct. Extension o credit in a orei$n c(rrenc! &o("d res("t in recei'in$ *a!)ent in "ess 'a"(a%"e do""ars i the orei$n c(rrenc! %eca)e "ess 'a"(a%"e. Th(s one &o("d not &ant to enco(ra$e $rantin$ trade credit in a orei$n co(ntr! &hen the co(ntr!Gs c(rrenc! is ex*ected to "ose 'a"(e. Ans&er 8-9 is incorrect %eca(se in'estin$ )onetar! assets into non)onetar! assets is ad'anta$eo(s &hen the )onetar! (nit is $oin$ to "ose 'a"(e. Ans&er 8C9 is incorrect %eca(se it is ad'anta$eo(s to %eco)e a de%tor &hen the )onetar! (nit is "osin$ 'a"(e. Ans&er 8D9 is incorrect %eca(se it is ad'anta$eo(s to %eco)e a de%tor &hen the )onetar! (nit is "osin$ 'a"(e. . Ans&er 8D9 is correct. A ir) )a! %(! or se"" or&ard exchan$e contracts to co'er "ia%i"ities or recei'a%"esA res*ecti'e"!A deno)inated in a orei$n c(rrenc!. An! $ain or "oss on the orei$n recei'a%"es or *a!a%"es %eca(se o chan$es in exchan$e rates is o set %! the "oss or $ain on the orei$n exchan$e contract. Ans&er 8A9 is incorrect %eca(se in $enera"A a ir) sho("d atte)*t to achie'e a net )onetar! de%tor *osition in co(ntries &ith c(rrencies ex*ected to de*reciate. Ans&er 8-9 is incorrect %eca(se a net )onetar! creditor *osition sho("d %e achie'ed in co(ntries &ith stren$thenin$ c(rrencies. Ans&er 8C9 is incorrect %eca(se a ir) )a! see, to )ini)i#e its exchan$e1rate ris, %! di'ersi ication. I it has transactions in %oth stron$ and &ea, c(rrenciesA the e ects o chan$es in rates )a! %e o settin$. . Ans&er 8-9 is correct. 3o"itica" ris, is the ris, that a orei$n $o'ern)ent )a! act in a &a! that &i"" red(ce the 'a"(e o the co)*an!Gs in'est)ent. 3o"itica" ris, )a! %e red(ced %! )a,in$ orei$n o*erations de*endent on the do)estic *arent or techno"o$!A )ar,etsA and s(**"ies. Ans&er 8A9 is incorrect %eca(se *o"itica" ris, )a! %e red(ced %! enterin$ into a +oint 'ent(re &ith a co)*an! ro) the host co(ntr! rather than ro) a orei$n co(ntr!. Ans&er 8C9 is incorrect %eca(se re (sin$ to *a! hi$her &a$es and hi$her taxes &i"" on"! increase *o"itica" ris,. Ans&er 8D9 is incorrect %eca(se *o"itica" ris, )a! %e red(ced %! inancin$ &ith "oca" ca*ita"A rather than orei$n ca*ita".
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. Ans&er 8C9 is correct. A easi%"e *ort o"io that o ers the hi$hest ex*ected ret(rn or a $i'en ris, or the "east ris, or a $i'en ex*ected ret(rn is ca""ed an e icient *ort o"io. Ans&er 8A9 is incorrect %eca(se an o*ti)a" *ort o"io is a *ort o"io se"ected ro) the e icient set o *ort o"ios %eca(se it is tan$ent to the in'estorGs hi$hest indi erence c(r'e. Ans&er 8-9 is incorrect %eca(se a desira%"e *ort o"io is a nonsense ter). Ans&er 8D9 is incorrect %eca(se an e ecti'e *ort o"io is a nonsense ter). . Ans&er 8D9 is correct. An in'estor &ants to )axi)i#e ex*ected ret(rn and )ini)i#e ris, &hen choosin$ a *ort o"io. A easi%"e *ort o"io that o ers the hi$hest ex*ected ret(rn or a $i'en ris, or the "east ris, or a $i'en ex*ected ret(rn is an e icient *ort o"io. A *ort o"io that is se"ected ro) the e icient set o *ort o"ios %eca(se it is tan$ent to the in'estorGs hi$hest indi erence c(r'e is the o*ti)a" *ort o"io. Ans&er 8A9 is incorrect %eca(se a *ort o"io is e icient i it o ers the hi$hest ret(rn or a $i'en ris, or the "east ris, or a $i'en ret(rn. Ans&er 8-9 is incorrect %eca(se the o*ti)a" *ort o"io is tan$ent to the in'estorGs hi$hest indi erence c(r'e. Th(sA it is the e icient *ort o"io &ith the hi$hest (ti"it!. Ans&er 8C9 is incorrect %eca(se the o*ti)a" *ort o"io is e icient as &e"" as easi%"e. . Ans&er 8A9 is correct. A co))on $enera" de inition is that ris, is an in'est)ent &ith an (n,no&n o(tco)e %(t a ,no&n *ro%a%i"it! distri%(tion o ret(rns 8a ,no&n )ean and standard de'iation9. An increase in the standard de'iation 8'aria%i"it!9 o ret(rns is s!non!)o(s &ith an increase in the ris,iness o a *ro+ect. Ris, is a"so increased &hen the *ro+ectGs ret(rns are *ositi'e"! 8direct"!9 corre"ated &ith other in'est)ents in the co)*an!Gs *ort o"ioK that isA ris, increases &hen ret(rns on a"" *ro+ects rise or a"" to$ether. Conse.(ent"!A the o'era"" ris, is decreased &hen *ro+ects ha'e "o& 'aria%i"it! and are ne$ati'e"! corre"ated 8the di'ersi ication e ect9. Ans&er 8-9 is incorrect %eca(se (ncorre"ated in'est)ents are )ore ris,! than ne$ati'e"! corre"ated in'est)ents. Ans&er 8C9 is incorrect %eca(se corre"ated in'est)ents are 'er! ris,!. Ans&er 8D9 is incorrect %eca(se corre"ated in'est)ents are 'er! ris,!. . Ans&er 8-9 is correct. -(siness (nits )a! %e treated as e"e)ents o an in'est)ent *ort o"io. A *ort o"io sho("d %e e icient in %a"ancin$ the ris, &ith the rate o ret(rn on the *ort o"io. The ex*ected rate o ret(rn o a *ort o"io is the &ei$hted a'era$e o the ex*ected ret(rns o the indi'id(a" assets in the *ort o"io. The 'aria%i"it! 8ris,9 o a *ort o"ioGs ret(rn is deter)ined %! the corre"ation o the ret(rns o indi'id(a" *ort o"io assets. To the extent the ret(rns are not *er ect"! *ositi'e"! corre"atedA 'aria%i"it! is decreased. Th(sA %(siness (nits sho("d %e se"ected that increase ret(rns and di'ersi ! and red(ce ris,. Ans&er 8A9 is incorrect %eca(se Michae" 3orterGs )ode" o co)*etiti'e strate$ies has t&o 'aria%"es6 co)*etiti'e ad'anta$e and co)*etiti'e sco*e. The strate$! ado*ted de*ends on &hether the ad'anta$e so($ht is %ased on "o&er cost or *rod(ct di erentiationA and on &hether the sco*e is %road or narro&. Ans&er 8C9 is incorrect %eca(se scenario de'e"o*)ent is a .(a"itati'e orecastin$ )ethod that in'o"'es *re*arin$ conce*t(a" scenarios o (t(re e'entsA $i'en care (""! de ined ass()*tions. It entai"s &ritin$ )("ti*"e a"ternati'e %(t e.(a""! "i,e"! descri*tions o (t(re states. A "on$it(dina" scenario indicates ho& the c(rrent circ()stances )a! de'e"o*A and a cross1sectiona" scenario descri%es *ossi%"e (t(re states at a desi$nated ti)e. Ans&er 8D9 is incorrect %eca(se sit(ationa" ana"!sis is a )ethod o deter)inin$ an or$ani#ationGs direction %! s!ste)atica""! )atchin$ its stren$ths and &ea,nesses &ith its en'iron)enta" o**ort(nities and threats 8re erred to as a S0OT ana"!sis9. . Mar,etA or s!ste)aticA or nondi'ersi ia%"eA ris, is *resent in a di'ersi ied *ort o"ioK the (ns!ste)atic ris, has %een e"i)inated. . The ris, re)ainin$ in di'ersi ied *ort o"ios is s!ste)atic ris,K th(sA *ort o"io ret(rns are co))ens(rate &ith s!ste)atic ris,. . ) and - .(anti ! the extra ret(rn in'estors de)and to %ear *ort o"io ris,.
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. Ans&er 8A9 is correct. The $enera" *rinci*"e is that ris, and ret(rn are direct"! corre"ated. ;.S. Treas(r! sec(rities are %ac,ed %! the ("" aith and credit o the edera" $o'ern)ent and are there ore the "east ris,! or) o in'est)ent. Bo&e'erA their ret(rn is corres*ondin$"! "o&er. Cor*orate irst )ort$a$e %onds are "ess ris,! than inco)e %onds or stoc, %eca(se the! are sec(red %! s*eci ic *ro*ert!. In the e'ent o de a("tA the %ondho"ders can ha'e the *ro*ert! so"d
to satis ! their c"ai)s. Bo"ders o irst )ort$a$es ha'e ri$hts *ara)o(nt to those o an! other *artiesA s(ch as ho"ders o second )ort$a$es. Inco)e %onds *a! interest on"! in the e'ent the cor*oration earns inco)e. Th(sA ho"ders o inco)e %onds ha'e "ess ris, than stoc,ho"ders %eca(se )eetin$ the condition )a,es *a!)ent o interest )andator!. 3re erred stoc,ho"ders recei'e di'idends on"! i the! are dec"aredA and the directors (s(a""! ha'e co)*"ete discretion in this )atter. A"soA stoc,ho"ders ha'e c"ai)s +(nior to those o de%tho"ders i the enter*rise is "i.(idated. Ans&er 8-9 is incorrect %eca(se the *ro*er "istin$ is )ort$a$e %ondsA s(%ordinated de%ent(resA inco)e %ondsA and *re erred stoc,. De%ent(res are (nsec(red de%t instr()ents. Their ho"ders ha'e en orcea%"e c"ai)s a$ainst the iss(er e'en i no inco)e is earned or di'idends dec"ared. Ans&er 8C9 is incorrect %eca(se the *ro*er "istin$ is irst )ort$a$e %ondsA second )ort$a$e %ondsA inco)e %ondsA and co))on stoc,. The second )ort$a$e %onds are sec(redA a"%eit +(niorA c"ai)s. Ans&er 8D9 is incorrect %eca(se the *ro*er "istin$ is )ort$a$e %ondsA de%ent(resA *re erred stoc,A and co))on stoc,. Bo"ders o co))on stoc, cannot recei'e di'idends (n"ess the ho"ders o *re erred stoc, recei'e the sti*("ated *eriodic *ercenta$e ret(rnA in addition to an! a'era$es i the *re erred stoc, is c()("ati'e.
30
. REF;IRED6 The "east ris,! sec(rit! ro) the 'ie&*oint o the in'estor. DISC;SSION6 8A9 A )ort$a$e %ond is sec(red &ith s*eci ic ixed assetsA (s(a""! rea" *ro*ert!. Th(sA (nder the ri$hts en()erated in the %ond indent(reA creditors &i"" %e a%"e to recei'e *a!)ents ro) "i.(idation o the *ro*ert! in case o de a("t. In a %an,r(*tc! *roceedin$A these a)o(nts are *aid %e ore an! trans ers are )ade to other creditorsA inc"(din$ those *re erences. BenceA )ort$a$e %onds are "ess ris,! than the others "isted. Ans&er 8-9 is incorrect %eca(se a de%ent(re is "on$1ter) de%t that is not sec(red 8co""atera"i#ed9 %! s*eci ic *ro*ert!. S(%ordinated de%ent(res ha'e a c"ai) on the de%torCs assets that )a! %e satis ied on"! a ter senior de%t has %een *aid in ("". De%ent(res o either ,ind are there ore )ore ris,! than )ort$a$e %onds. Ans&er 8C9 is incorrect %eca(se an inco)e %ond *a!s interest on"! i the de%tor earns it. S(ch %onds are a"so )ore ris,! than sec(red de%t. Ans&er 8D9 is incorrect %eca(se (nsec(red de%t is ris,ier than a )ort$a$e %ond. . Ans&er 8D9 is correct. The standard de'iation is a )eas(re o the de$ree o co)*actness o the 'a"(es in a *o*("ation. It is a )eas(re o dis*ersion. The standard de'iation is o(nd %! ta,in$ the s.(are root o the .(otient o the s() o the s.(ared de'iations ro) the )eanA di'ided %! the n()%er o ite)s in the *o*("ation. Corn has a )ean ret(rn o /<J and a standard de'iation o 1@J. BenceA it is not as ris,! as M(stA &hich has a standard de'iation o >J re"ati'e to a )ean o on"! 1<J. The coe icient o 'ariation 8standard de'iation X ex*ected ret(rn9 is )(ch hi$her or M(st 8<.> X .1< S .>9 than or Corn 8.1@ X ./< S .?@9. Ans&er 8A9 is incorrect %eca(se the existence o a hi$her ret(rn is not necessari"! indicati'e o hi$h ris,. Ans&er 8-9 is incorrect %eca(se the hi$her standard de'iation )(st %e 'ie&ed re"ati'e to the )ean o the *o*("ation. Ans&er 8C9 is incorrect %eca(se M(st does not ha'e the hi$her standard de'iation. . Ans&er 8A9 is correct. The re.(ired rate o ret(rn on e.(it! ca*ita" in the ca*ita" asset *ricin$ )ode" is the ris,1 ree rate 8deter)ined %! $o'ern)ent sec(rities9 *"(s the *rod(ct o the )ar,et ris, *re)i() ti)es the %eta coe icient 8%eta )eas(res the ir)Gs ris,9. The )ar,et ris, *re)i() is the a)o(nt a%o'e the ris,1 ree rate that &i"" ind(ce in'est)ent in the )ar,et. The %eta coe icient o an indi'id(a" stoc, is the corre"ation %et&een the 'o"ati"it! 8*rice 'ariation9 o the stoc, )ar,et and that o the *rice o the indi'id(a" stoc,. Ans&er 8-9 is incorrect %eca(se the coe icient o 'ariation is the standard de'iation o an in'est)entGs ret(rns di'ided %! the )ean ret(rn. Ans&er 8C9 is incorrect %eca(se the standard de'iation is a )eas(re o the 'aria%i"it! o an in'est)entGs ret(rns. Ans&er 8D9 is incorrect %eca(se the %eta coe icient )eas(res the sensiti'it! o the in'est)entGs ret(rns to )ar,et 'o"ati"it!. . Ans&er 8C9 is correct. The CA3M )eas(res the tradeo %et&een in'est)ent ret(rn and ris,. The ret(rn is the ris,1 ree ret(rn *"(s a ris, *re)i(). Th(sA the CA3M theor! ana"!#es *ort o"ios in ter)s o their rate o ret(rn and ris,A and the e ect o addin$ additiona" sec(rities to the *ort o"io. Ans&er 8A9 is incorrect %eca(se CA3M is a *ort o"io 8not sin$"e sec(rit!9 theor!. Ans&er 8-9 is incorrect %eca(se the CA3M is a $enera" theor! that is not s*eci ic to an! sec(rit! tradin$ strate$ies. Ans&er 8D9 is incorrect %eca(se the CA3M a**"ies to in'est)ent sec(ritiesA not ixed assets. . 0ith a di'ersi ied *ort o"ioA the on"! ris, re)ainin$ is )ar,etA or s!ste)aticA ris,. This is the on"! ris, that in "(ences ret(rn accordin$ to the CA3M.
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. Ans&er 8C9 is correct. The ris, o concern to in'estors &ho s(**"! ca*ita" to a di'ersi ied co)*an! is )ar,et ris,. -eta or )ar,et ris, is the ris, that cannot %e e"i)inated %! di'ersi ication. This t!*e o ris, is de ined ro) the *ers*ecti'e o an in'estor &ho 'ie&s the in'est)ent as +(st one *art o a di'ersi ied *ort o"io. It is the a'era$e ris, o the ir)Gs in'est)ent *ro+ects ca"c("ated as the &ei$hted a'era$e o *ro+ect %etas. Ans&er 8A9 is incorrect %eca(seA in *ro+ect ris, assess)entA the ir) atte)*ts to assess the "e'e" o ris, or a $i'en *ro+ect %! considerin$A or a $i'en *ro+ectA either *(re *"a! %etas or acco(ntin$ %etas 8%eta 'a"(es deter)ined ro) acco(ntin$ data rather than ro) re$ression o a co)*an!Gs stoc, ret(rns on a stoc, )ar,et index9. Neither is a s( icient )eans or assessin$ the o'era"" ris, o a di'ersi ied ir). Ans&er 8-9 is incorrect %eca(seA in the *(re *"a! )ethod o *ro+ect ris, assess)entA the ir) atte)*ts to esti)ate %eta or a sin$"e *rod(ct co)*an! in the sa)e "ine o %(siness as the *ro+ect %ein$ e'a"(ated. Ans&er 8D9 is incorrect %eca(seA in *ro+ect ris, assess)entA the ir) atte)*ts to assess the "e'e" o ris, or a $i'en *ro+ect %! considerin$A or a $i'en *ro+ectA either *(re *"a! %etas or acco(ntin$ %etas 8%eta 'a"(es deter)ined ro) acco(ntin$ data rather than ro) re$ression o a co)*an!Gs stoc, ret(rns on a stoc, )ar,et index9. Neither is a s( icient )eans or assessin$ the o'era"" ris, o a di'ersi ied ir). . Ans&er 8A9 is correct. There is a *ositi'e re"ationshi* %et&een a ir)Gs %eta 'a"(e and the disco(nt rate a**"ied to cash "o&s. Th(sA a decrease in %eta 'a"(e &i"" red(ce the disco(nt rate. Ans&er 8-9 is incorrect %eca(se the disco(nt rate &i"" %e red(cedA not increased. Ans&er 8C9 is incorrect %eca(se the disco(nt rate &i"" %e red(ced. Ans&er 8D9 is incorrect %eca(se a #ero disco(nt rate incorrect"! s($$ests that (t(re cash "o&s do not need to %e disco(nted or e'a"(ation *(r*oses. . REF;IRED6 The ris,ier stoc,. DISC;SSION6 8E9 The standard de'iation is a )eas(re o the de$ree o co)*actness o the 'a"(es in a *o*("ation. It is a )eas(re o dis*ersion. The standard de'iation is o(nd %! ta,in$ the s.(are root o the .(otient o the s() o the s.(ared de'iations ro) the )eanA di'ided %! the n()%er o ite)s in the *o*("ation. In other &ordsA the standard de'iation descri%es ho& ar ro) the )ean the 'ario(s e"e)ents o the *o*("ation are. Cornh(s,er has a )ean ret(rn o /<J and a standard de'iation o 1@J. BenceA it is not as ris,! as M(stan$A &hich has a standard de'iation o >J re"ati'e to a )ean o on"! 1<J. The coe icient o 'ariation 8standard de'iation X ex*ected ret(rn9 is )(st hi$her or M(stan$ 8<.<> X <.1< S <.>9 than or Cornh(s,er 8<.1@ X <./< S <.?@9. Ans&er 8A9 is incorrect %eca(se the existence o a hi$her ret(rn is not necessari"! indicati'e o hi$h ris,. Ans&er 8-9 is incorrect %eca(se is incorrect %eca(se the hi$her standard de'iation )(st %e 'ie&ed re"ati'e to the )ean o the *o*("ationK the a%so"(te "e'e" o the standard de'iation is )eanin$"ess &itho(t a ,no&"ed$e o the )ean. Ans&er 8C9 is incorrect %eca(se M(stan$ does not ha'e the hi$her standard de'iation. Ans&er 8D9 is incorrect %eca(se the a%so"(te "e'e" o M(stan$Cs rate o ret(rn is not indicati'e o ris,. . Ans&er 8D9 is correct. An i)*ortant )eas(re)ent (sed in *ort o"io ana"!sis is the co'ariance. It )eas(res the 'o"ati"it! o ret(rns to$ether &ith their corre"ation &ith the ret(rns o other sec(rities. :or t&o stoc,s E and YA i , is the ex*ected ret(rnA ,i is a $i'en o(tco)eA and *i is its *ro%a%i"it!A the co'ariance o E and Y is
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# "$k k # "p C%&$'(" = $k !i k ! i i

i =1
Ans&er 8A9 is incorrect %eca(se the 'ariance and standard de'iation are ca"c("ated or a sin$"e in'est)ent. The standard de'iation $i'es an exact 'a"(e or the ti$htness o the distri%(tion and the ris,iness o the in'est)ent. The standard de'iation 8\9 is the s.(are root o the 'ariance. Ans&er 8-9 is incorrect %eca(se the 'ariance and standard de'iation are ca"c("ated or a sin$"e in'est)ent. The standard de'iation $i'es an exact 'a"(e or the ti$htness o the distri%(tion and the ris,iness o the in'est)ent. The standard de'iation 8\9 is the s.(are root o the 'ariance. Ans&er 8C9 is incorrect %eca(se the coe icient o 'ariation is ca"c("ated or a sin$"e in'est)ent. The coe icient o 'ariation is (se (" &hen the rates o ret(rn and standard de'iations o t&o in'est)ents di er. It )eas(res the ris, *er (nit o ret(rn %eca(se it di'ides the standard de'iation %! the ex*ected ret(rn.
39
. Ans&er 8-9 is correct. The co'ariance )eas(res the 'o"ati"it! o ret(rns to$ether &ith their corre"ation &ith the ret(rns o other sec(rities. It is ca"c("ated &ith the o""o&in$ e.(ation6
# "$k k # "p C%&$'(" = $k !i k ! i i

i =1
The co'ariance o t&o stoc,s is the sa)e re$ard"ess o &hich stoc, is co)*ared to the other. Ans&er 8A9 is incorrect %eca(se the co'ariance o stoc, - &ith stoc, A is the sa)e as the co'ariance o stoc, A &ith stoc, -. Ans&er 8C9 is incorrect %eca(se the co'ariance o stoc, - &ith stoc, A is the sa)e as the co'ariance o stoc, A &ith stoc, -. Ans&er 8D9 is incorrect %eca(se the co'ariance o stoc, - &ith stoc, A is the sa)e as the co'ariance o stoc, A &ith stoc, -.
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. Ans&er 8C9 is correct. An indi erence c(r'e re*resents co)%inations o *ort o"ios ha'in$ e.(a" (ti"it! to the in'estor. Gi'en that ris, and ret(rns are *"otted on the hori#onta" and 'ertica" axesA res*ecti'e"!A and that the in'estor is ris, a'erseA the c(r'e has an increasin$"! *ositi'e s"o*e. As ris, increasesA the additiona" re.(ired ret(rn *er (nit o additiona" ris, a"so increases. The stee*er the s"o*e o an indi erence c(r'eA the )ore ris, a'erse an in'estor is. The hi$her the c(r'eA the $reater is the in'estorGs "e'e" o (ti"it!. Ans&er 8A9 is incorrect %eca(se the s"o*e is "ess stee* i the in'estor is "ess ris, a'erse. The increase in the re.(ired additiona" ret(rn *er (nit o additiona" ris, is "o&er. Ans&er 8-9 is incorrect %eca(se the hi$her the c(r'eA the $reater is the in'estorGs "e'e" o (ti"it!. Moreo'erA the s"o*e is *ositi'eA not ne$ati'e. Ans&er 8D9 is incorrect %eca(se the s"o*e is increasin$"! *ositi'e. . Ans&er 8A9 is correct. The ex*ected rate o ret(rn o a *ort o"io is the &ei$hted a'era$e o the ex*ected ret(rns o the indi'id(a" assets in the *ort o"io. Ans&er 8-9 is incorrect %eca(se the interest rate or the sa est *ossi%"e in'est)ent is direct"! (sed in the ca*ita" asset *ricin$ )ode". Ans&er 8C9 is incorrect %eca(se the ex*ected rate o ret(rn on the )ar,et *ort o"io is the one s!ste)atic ris, actor in the )ode". Ans&er 8D9 is incorrect %eca(se the standard de'iation o the )ar,et ret(rns is (sed to co)*(te the %eta coe icients or each sec(rit! he"d in the in'est)ent *ort o"io and the %eta coe icient or the )ar,et *ort o"io. . Ans&er 8D9 is correct. The corre"ation coe icient 8r9 )eas(res the de$ree to &hich an! t&o 'aria%"es are re"ated. It ran$es ro) 11.< to 1.<. 3er ect *ositi'e corre"ation 81.<9 )eans that the t&o 'aria%"es a"&a!s )o'e to$ether. 3er ect ne$ati'e corre"ation 811.<9 )eans that the t&o 'aria%"es a"&a!s )o'e in'erse"! to one another. A ne(tra" corre"ationA or no corre"ationA is <.<. S,e&ed is a nonsense conce*t in this context. Ans&er 8A9 is incorrect %eca(se ret(rns on t&o stoc,s can %e corre"ated in an! 'a"(e that a""s &ithin the ran$e o 11.< to 1.<. Ans&er 8-9 is incorrect %eca(se ret(rns on t&o stoc,s can %e corre"ated in an! 'a"(e that a""s &ithin the ran$e o 11.< to 1.<. Ans&er 8C9 is incorrect %eca(se ret(rns on t&o stoc,s can %e corre"ated in an! 'a"(e that a""s &ithin the ran$e o 11.< to 1.<. . Ans&er 8D9 is correct. Mat(rit! )atchin$A or e.(a"i#in$ the "i e o an asset and the de%t instr()ent (sed to inance that assetA is a hed$in$ a**roach. The %asic conce*t is that the co)*an! has the entire "i e o the asset to reco'er the a)o(nt in'ested %e ore ha'in$ to *a! the "ender. Ans&er 8A9 is incorrect %eca(se &or,in$ ca*ita" )ana$e)ent is short1ter) asset )ana$e)ent. Ans&er 8-9 is incorrect %eca(se ret(rn )axi)i#ation is )ore a$$ressi'e than )at(rit! )atchin$. It entai"s (sin$ the "o&est cost or)s o inancin$. Ans&er 8C9 is incorrect %eca(se inancia" "e'era$e is the re"ationshi* %et&een de%t and e.(it! inancin$. . Ans&er 8A9 is correct. S&a*s are contracts to hed$e ris, %! exchan$in$ cash "o&s. In an interest1rate s&a*A one ir) exchan$es its ixed interest and *rinci*a" *a!)ents or a series o *a!)ents %ased on a "oatin$ rate. I a ir) has de%t &ith ixed char$esA %(t its re'en(es "(ct(ate &ith interest ratesA it )a! *re er to s&a* or cash o(t "o&s %ased on a "oatin$ rate. The ad'anta$e is that re'en(es and the a)o(nts o de%t ser'ice &i"" then )o'e in the sa)e directionA and interest1rate ris, &i"" %e red(ced. A c(rrenc! s&a* is an exchan$e o an o%"i$ation to *a! o(t cash "o&s deno)inated in one c(rrenc! or an o%"i$ation to *a! in another. :or exa)*"eA a ;.S. ir) &ith re'en(es in rancs has to *a! s(**"iers and &or,ers in do""arsA not rancs. To )ini)i#e exchan$e1rate ris,A it )i$ht a$ree to exchan$e rancs or do""ars he"d %! a ir) that needs rancs. The exchan$e rate &i"" %e an a'era$e o the rates ex*ected o'er the "i e o the a$ree)ent. Ans&er 8-9 is incorrect %eca(se contracts to hed$e ris, %! exchan$in$ cash "o&s inc"(de interest1rate s&a*s and c(rrenc! s&a*s. Ans&er 8C9 is incorrect %eca(se contracts to hed$e ris, %! exchan$in$ cash "o&s inc"(de interest1rate s&a*s and c(rrenc! s&a*s. Ans&er 8D9 is incorrect %eca(se contracts to hed$e ris, %! exchan$in$ cash "o&s inc"(de
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interest1rate s&a*s and c(rrenc! s&a*s.

45
. Ans&er 8C9 is correct. Deri'ati'esA inc"(din$ o*tions and (t(resA are contracts %et&een the *arties &ho contract. ;n"i,e stoc,s and %ondsA the! are not c"ai)s on %(siness assets. A (t(res contract is entered into as either a s*ec("ation or a hed$e. S*ec("ation in'o"'es the ass()*tion o ris, in the ho*e o $ainin$ ro) *rice )o'e)ents. Bed$in$ is the *rocess o (sin$ o settin$ co))it)ents to )ini)i#e or a'oid the i)*act o ad'erse *rice )o'e)ents. Ans&er 8A9 is incorrect %eca(se hed$in$ decreases ris, %! (sin$ o settin$ co))it)ents that a'oid the i)*act o ad'erse *rice )o'e)ents. Ans&er 8-9 is incorrect %eca(se s*ec("ation in'o"'es the ass()*tion o ris, in the ho*e o $ainin$ ro) *rice )o'e)ents. Ans&er 8D9 is incorrect %eca(se s*ec("atin$ increases ris, &hi"e hed$in$ o sets ris,. . Ans&er 8-9 is correct. A *(t o*tion is the ri$ht to se"" stoc, at a $i'en *rice &ithin a certain *eriod. I the )ar,et *rice a""sA the *(t o*tion )a! a""o& the sa"e o stoc, at a *rice a%o'e )ar,etA and the *ro it o the o*tion ho"der &i"" %e the di erence %et&een the *rice stated in the *(t o*tion and the )ar,et *riceA )in(s the cost o the o*tionA co))issionsA and taxes. The co)*an! that iss(es the stoc, has nothin$ to do &ith *(t 8and ca""9 o*tions. Ans&er 8A9 is incorrect %eca(se a ca"" o*tion is the ri$ht to *(rchase shares at a $i'en *rice &ithin a s*eci ied *eriod. Ans&er 8C9 is incorrect %eca(se se""in$ a *(t o*tion co("d orce the co)*an! to *(rchase additiona" stoc, i the o*tion is exercised. Ans&er 8D9 is incorrect %eca(se a &arrant $i'es the ho"der a ri$ht to *(rchase stoc, ro) the iss(er at a $i'en *rice 8it is (s(a""! distri%(ted a"on$ &ith de%t9. . Ans&er 8C9 is correct. The $oa" o d(ration hed$in$ is not to e.(ate the d(ration o assets and the d(ration o "ia%i"ities %(t or the o""o&in$ re"ationshi* to a**"!6 8Va"(e o assets9 E 8D(ration o assets98Va"(e o "ia%i"ities9 E 8D(ration o "ia%i"ities9The ir) is i))(ni#ed a$ainst interest1rate ris, &hen the tota" *rice chan$e or assets e.(a"s the tota" *rice chan$e or "ia%i"ities. Ans&er 8A9 is incorrect %eca(se i d(ration increasesA the 'o"ati"it! o the *rice o a de%t instr()ent. Ans&er 8-9 is incorrect %eca(se the $oa" is to e.(ate the tota" *rice chan$e or assets and the tota" *rice chan$e or "ia%i"ities. Ans&er 8D9 is incorrect %eca(se d(ration is "o&er i the no)ina" rate on a de%t instr()ent is hi$her. . Ans&er 8C9 is correct. A or&ard contract is an exec(tor! contract in &hich the *arties in'o"'ed a$ree to the ter)s o a *(rchase and a sa"eA %(t *er or)ance is de erred. Accordin$"!A a or&ard contract in'o"'es a co))it)ent toda! to *(rchase a *rod(ct on a s*eci ic (t(re date at a *rice deter)ined toda!. Ans&er 8A9 is incorrect %eca(se the *rice o a (t(re contract is deter)ined on the da! o co))it)entA not so)e ti)e in the (t(re. Ans&er 8-9 is incorrect %eca(se *er or)ance is de erred in a (t(re contractA and the *rice o the *rod(ct is not necessari"! its *resent *rice. The *rice can %e an! *rice deter)ined on the da! o co))it)ent. Ans&er 8D9 is incorrect %eca(se a or&ard contract is a ir) co))it)ent to *(rchase a *rod(ct. It is not %ased on a contin$enc!. A"soA a or&ard contract does not in'o"'e an exercise *rice 8exercise *rice is in an o*tion contract9. . Ans&er 8-9 is correct. Interest rate (t(res contracts in'o"'e ris,1 ree %ondsA s(ch as ;.S. Treas(r! %onds. 0hen interest rates decrease o'er the *eriod o a or&ard contractA the 'a"(e o the %onds and the or&ard contract increase. Ans&er 8A9 is incorrect %eca(se the 'a"(e o the or&ard contract &i"" increase &hen interest rates decrease. Ans&er 8C9 is incorrect %eca(se the 'a"(e o the or&ard contract &i"" increase &hen interest rates decrease. Ans&er 8D9 is incorrect %eca(se an! dec"ine in interest rates increases the 'a"(e o the %onds. . Ans&er 8D9 is correct. A distin$(ishin$ eat(re o (t(res contracts is that their *rices are )ar,ed to )ar,et e'er! da! at the c"ose o the da!. Th(sA the )ar,et *rice is *osted at the c"ose o %(siness each da!. A )ar,1to1)ar,et *ro'ision )ini)i#es a (t(res contractGs chance o de a("t %eca(se *ro its and "osses on the contracts )(st %e recei'ed or *aid each da! thro($h a c"earin$ho(se. Ans&er 8A9 is incorrect %eca(se %oth a or&ard contract and a (t(res contract are exec(tor!. Ans&er 8-9 is incorrect %eca(se a (t(res contract )a! %e s*ec("ati'e. Ans&er 8C9 is incorrect %eca(se a (t(res contract is or de"i'er! d(rin$ a $i'en )onth. . Ans&er 8-9 is correct. A chan$e in *rices can %e )ini)i#ed or a'oided %! hed$in$. Bed$in$ is the *rocess o (sin$ o settin$ co))it)ents to )ini)i#e or a'oid the i)*act o ad'erse *rice )o'e)ents. The a(to)o%i"e co)*an! desires to sta%i"i#e the *rice o stee" so that its cost to the co)*an! &i"" not rise and c(t into *ro its. Accordin$"!A the a(to)o%i"e
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co)*an! (ses the (t(res )ar,et to create a "on$ hed$eA &hich is a (t(res contract that is *(rchased to *rotect a$ainst *rice increases. Ans&er 8A9 is incorrect %eca(se a short hed$e is a (t(res contract that is so"d to *rotect a$ainst *rice dec"ines. The a(to)o%i"e co)*an! &ishes to *rotect itse" a$ainst *rice increases. Ans&er 8C9 is incorrect %eca(se the a(to)o%i"e co)*an! needs to *(rchase (t(res in order to *rotect itse" ro) "ossA not se"" (t(res. Se""in$ (t(res *rotects a$ainst *rice dec"ines. Ans&er 8D9 is incorrect %eca(se it is the de inition o a short hed$eA &hich is (sed or a'oidin$ *rice dec"ines. The a(to)o%i"e co)*an! &ants to *rotect itse" a$ainst *rice increases.
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. Ans&er 8D9 is correct. In an interest rate s&a*A t&o co)*anies exchan$e their de%t ser'icin$ o%"i$ations. S(ch a transaction arises %eca(se the co)*anies 8ca""ed the co(nter *arties9 &ish to "i)it interest rate ris,. I a co)*an! &ith a 'aria%"e1rate "oan desires the certaint! o a ixed1rate "oanA it )a! s&a* &ith a co)*an! that *re ers the "oatin$ rate. The act(a" exchan$e o (nds d(rin$ the a$ree)ent is in the or) o a net *a!)ent ro) the *art! o&in$ the $reater a)o(nt or the *eriod. Interest rate s&a*s are a or) o o 1%a"ance1sheet inancin$ %eca(se on"! the ori$ina" %orro&in$A not the s&a* a$ree)entA a**ears on the %a"ance sheet. Ans&er 8A9 is incorrect %eca(se an interest rate s&a* is not a sa"e o a ri$ht to %orro& at a *re erentia" rate. Ans&er 8-9 is incorrect %eca(se the *arties to an interest rate s&a* dea" on"! &ith each other. Ans&er 8C9 is incorrect %eca(se an interest rate s&a* is an exchan$e o interest o%"i$ationsA not an o settin$ o interest inco)e and interest ex*ense. . Ans&er 8A9 is correct. S&a*s are contracts to hed$e ris, %! exchan$in$ cash "o&s. In an interest1rate s&a*A one ir) exchan$es its ixed interest and *rinci*a" *a!)ents or a series o *a!)ents %ased on a "oatin$ rate. I a ir) has de%t &ith ixed char$esA %(t its re'en(es "(ct(ate &ith interest ratesA it )a! *re er to s&a* or cash o(t "o&s %ased on a "oatin$ rate. The ad'anta$e is that re'en(es and the a)o(nts o de%t ser'ice &i"" then )o'e in the sa)e directionA and interest1rate ris, &i"" %e red(ced. A c(rrenc! s&a* is an exchan$e o an o%"i$ation to *a! o(t cash "o&s deno)inated in one c(rrenc! or an o%"i$ation to *a! in another. :or exa)*"eA a ;.S. ir) &ith re'en(es in rancs has to *a! s(**"iers and &or,ers in do""arsA not rancs. To )ini)i#e exchan$e1rate ris,A it )i$ht a$ree to exchan$e rancs or do""ars he"d %! a ir) that needs rancs. The exchan$e rate &i"" %e an a'era$e o the rates ex*ected o'er the "i e o the a$ree)ent. Ans&er 8-9 is incorrect %eca(se contracts to hed$e ris, %! exchan$in$ cash "o&s inc"(de interest1rate s&a*s and c(rrenc! s&a*s. Ans&er 8C9 is incorrect %eca(se contracts to hed$e ris, %! exchan$in$ cash "o&s inc"(de interest1rate s&a*s and c(rrenc! s&a*s. Ans&er 8D9 is incorrect %eca(se contracts to hed$e ris, %! exchan$in$ cash "o&s inc"(de interest1rate s&a*s and c(rrenc! s&a*s. . Ans&er 8A9 is correct. ;nder sensiti'it! ana"!sisA orecasts o )an! ca"c("ated N3Vs (nder 'ario(s ass()*tions are co)*ared to see ho& sensiti'e the N3V o a *ossi%"e *ro+ect is to the chan$e o a sin$"e in*(t 'aria%"e. In this instanceA the sin$"e (nit 'aria%"e %ein$ chan$ed is the *rice o a ta%"e. Ans&er 8-9 is incorrect %eca(se si)("ation ana"!sis re.(ires the (se o a co)*(ter to $enerate )an! exa)*"es o res("ts %ased (*on 'ario(s ass()*tions. Ans&er 8C9 is incorrect %eca(se the in or)a" )ethod ca"c("ates N3Vs at the ir)Gs disco(nt rate 8,9 and indi'id(a""! re'ie&s the *ossi%"e *ro+ects. Ans&er 8D9 is incorrect %eca(se certaint! e.(i'a"ent ad+(st)ents are not re.(ent"! (sed since decision )a,ers are not a)i"iar &ith its conce*t. It orces the decision )a,er to s*eci ! at &hat *oint the ir) is indi erent to the choice %et&een a certain s() o )one! and the ex*ected 'a"(e o a ris,! s(). . Ans&er 8A9 is correct. Si)("ation ana"!sis considers %oth the sensiti'it! o the N3V &hen 'aria%"es are chan$ed and the ran$e o 'a"(es o the 'aria%"es that are chan$ed. Ans&er 8-9 is incorrect %eca(se The Ca*ita" Asset 3ricin$ Mode" is deri'ed ro) the (se o *ort o"io theor!. Ans&er 8C9 is incorrect %eca(se sensiti'it! ana"!sis on"! considers the sensiti'it! o the N3V &hen 'aria%"es are chan$edA not the ran$e o 'a"(es o the 'aria%"es that are chan$ed. Ans&er 8D9 is incorrect %eca(se certaint! e.(i'a"ent ad+(st)ents does not in'o"'e ca"c("atin$ N3Vs. . Ans&er 8D9 is correct. Ris, ana"!sis atte)*ts to )eas(re the "i,e"ihood o the 'aria%i"it! o (t(re ret(rns ro) the *ro*osed in'est)ent. Ris, can %e incor*orated into ca*ita" %(d$etin$ decisions in a n()%er o &a!sA one o &hich is to (se a h(rd"e rate hi$her than the ir)Gs cost o ca*ita"A that isA a ris,1ad+(sted disco(nt rate. This techni.(e ad+(sts the interest rate (sed or disco(ntin$ (*&ard as an in'est)ent %eco)es ris,ier. The ex*ected "o& ro) the in'est)ent )(st %e re"ati'e"! "ar$erA or the increased disco(nt rate &i"" $enerate a ne$ati'e net *resent 'a"(eA and the *ro*osed ac.(isition &i"" %e re+ected. Accordin$"!A the IRR 8the rate at &hich the N3V is #ero9 or a re+ected in'est)ent )a!
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exceed the cost o ca*ita" &hen the ris,1ad+(sted rate is hi$her than the IRR. Con'erse"!A the IRR or an acce*ted in'est)ent )a! %e "ess than the cost o ca*ita" &hen the ris,1ad+(sted rate is "ess than the IRR. In this caseA the in'est)ent *res()a%"! has 'er! "itt"e ris,. :(rther)oreA ris,1ad+(sted rates )a! a"so re "ect the di erin$ de$rees o ris,A not on"! a)on$ in'est)entsA %(t %! the sa)e in'est)ents (nderta,en %! di erent or$ani#ationa" s(%(nits. Ans&er 8A9 is incorrect %eca(se disco(nt rates )a! 'ar! &ith the *ro+ect or &ith the s(%(nit o the or$ani#ation. Ans&er 8-9 is incorrect %eca(se the co)*an! )a! acce*t so)e *ro+ects &ith IRRs "ess than the cost o ca*ita"A or re+ect so)e *ro+ect &ith IRRs $reater than the cost o ca*ita". Ans&er 8C9 is incorrect %eca(se the co)*an! )a! acce*t so)e *ro+ects &ith IRRs "ess than the cost o ca*ita"A or re+ect so)e *ro+ect &ith IRRs $reater than the cost o ca*ita".
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3 ks 9 :;< = 4:>< - :;<5:3? 9 :;< = @< 9 :@<3 Ex*ected ret(rn S /1J. /1J 1 Ris, ad+(st)ent 1J S /<J. Ris,1ad+(sted ret(rn S /<J T ,s S 1>J. Calculate the beta of the firm, and use to calculate project beta: ,s S <.1= S <.1< Q 8<.<@9%:ir). %:ir) S 1./. %3ro+ect S 8%:ir)91.@. 8%3ro+ect is @<J $reater than c(rrent %:ir)9 %3ro+ect S 81./91.@ S 1.D. Calculate required return on project, kProject, and compare to expected return: 3ro+ect6 ,3ro+ect S <.1< Q 8<.<@91.D S <.1> S 1>J. Ex*ected ret(rn S <.1D S 1DJ. Since the re.(ired ret(rn is one *ercenta$e *oint $reater than the ex*ected ret(rnA the ir) sho("d not acce*t the ne& *ro+ect.
@D
@>
Calculate the beta of the firm, and use to calculate project beta: ,s S <.1= S <.1< Q 8<.<@9%:ir). %:ir) S 1./. %3ro+ect S 8%:ir)91.@ 8%3ro+ect is @<J $reater than c(rrent %:ir)9 %3ro+ect S 81./91.@ S 1.D. Calculate required return on project, kProject, and compare to IRR. 3ro+ect6 ,3ro+ect S <.1< Q 8<.<@91.D S <.1> S 1>J. IRR S <.1D S 1DJ. Since the re.(ired ret(rn is one *ercenta$e *oint $reater than the ex*ected IRRA the ir) sho("d not acce*t the ne& *ro+ect. . Ans&er 8C9 is correct. The theor! (nder"!in$ the cost o ca*ita" is %ased *ri)ari"! on the cost o "on$1ter) (nds and the ac.(isition o ne& (nds. The reason is that "on$1ter) (nds are (sed to inance "on$1ter) in'est)ents. :or an in'est)ent a"ternati'e to %e 'ia%"eA the ret(rn on the in'est)ent )(st %e $reater than the cost o the (nds (sed. The o%+ecti'e in short1ter) %orro&in$ is di erent. Short1ter) "oans are (sed or &or,in$ ca*ita"A not to inance "on$1ter) in'est)ents. Ans&er 8A9 is incorrect %eca(se the concern is &ith the cost o ne& (ndsK the cost o o"d (nds is a s(n, cost and o no re"e'ance or decision1)a,in$ *(r*oses. Ans&er 8-9 is incorrect %eca(se the cost o short1ter) (nds is not (s(a""! a concern or in'est)ent *(r*oses. Ans&er 8D9 is incorrect %eca(se there is "ess concern &ith the cost o o"d (nds or short1ter) (nds. . Ans&er 8C9 is correct. The cost o ca*ita" is the )ini)()A not )axi)()A rate o ret(rn that )(st %e earned on ne& in'est)ents so as not to di"(te shareho"der interest. I ne& in'est)ents ha'e a rate o ret(rn "ess than the cost o ca*ita"A a "oss &i"" %e inc(rred on those in'est)ents. Th(sA the cost o ca*ita" )(st %e the )ini)() rate o ret(rn. See SMA 4AA Cost o Ca*ita". Ans&er 8A9 is incorrect %eca(se cost o ca*ita" is (sed to )a,e ca*ita" in'est)ent decisions so that each in'est)ent ret(rns )ore than the cost o ca*ita". Ans&er 8-9 is incorrect %eca(se the cost o )aintainin$ &or,in$ ca*ita" is %ased on the cost o ca*ita". Ans&er 8D9 is incorrect %eca(se the *er or)ance o indi'id(a" in'est)entsA in'est)ent )ana$ersA and others can %e re"ated to the cost o ca*ita". . Ans&er 8D9 is correct. The ;1sha*ed c(r'e indicates that the cost o ca*ita" is .(ite hi$h &hen the de%t1to1e.(it! ratio is .(ite "o&. As de%t increasesA the cost o ca*ita" dec"ines as "on$ as the cost o de%t is "ess than that o e.(it!. E'ent(a""!A the dec"ine in the cost o ca*ita" "e'e"s o %eca(se the cost o de%t ("ti)ate"! rises as )ore de%t is (sed.
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Additiona" increases in de%t 8re"ati'e to e.(it!9 &i"" then increase the cost o ca*ita". The i)*"ication is that so)e de%t is *resent in the o*ti)a" ca*ita" str(ct(re %eca(se the cost o ca*ita" initia""! dec"ines &hen de%t is added. Bo&e'erA a *oint is reached at &hich de%t %eco)es excessi'e and the cost o ca*ita" %e$ins to rise. Ans&er 8A9 is incorrect %eca(se the co)*osition o the ca*ita" str(ct(re a ects the cost o ca*ita" since the co)*onents ha'e di erent costs. Ans&er 8-9 is incorrect %eca(se the cost o de%t does not re)ain constant as inancia" "e'era$e increases. E'ent(a""!A that cost a"so increases. Ans&er 8C9 is incorrect %eca(se the initia" dec"ine in the ;1sha*ed $ra*h indicates that the inancia" )ar,ets re&ard )oderate "e'e"s o de%t.
63
. Ans&er 8A9 is correct. The o'era"" cost o ca*ita" is the rate o ret(rn on a ir)Gs assets that exact"! co'ers the costs associated &ith the (nds e)*"o!ed. It is the &ei$hted a'era$e o the 'ario(s de%t and e.(it! co)*onents. Ans&er 8-9 is incorrect %eca(se the cost o ca*ita" is %ased on &hat a co)*an! *a!s or its ca*ita"A not the ret(rn earned on the ca*ita" e)*"o!ed. Ans&er 8C9 is incorrect %eca(se the o'era"" cost o ca*ita" is the )ini)() rate a ir) )(st earn on a"" in'est)ents to co'er ca*ita" costs. Ans&er 8D9 is incorrect %eca(se the o'era"" cost o ca*ita" is %ased on %oth de%t and e.(it! co)*onents. . Ans&er 8A9 is correct. An i)*(ted cost is one that has to %e esti)ated. It is a cost that exists %(t is not s*eci ica""! stated and is the res("t o a *rocess desi$ned to reco$ni#e econo)ic rea"it!. An i)*(ted cost )a! not re.(ire a do""ar o(t"a! or)a""! reco$ni#ed %! the acco(ntin$ s!ste)A %(t it is re"e'ant to the decision1)a,in$ *rocess. :or exa)*"eA the stated interest on a %an, "oan is not an i)*(ted cost %eca(se it is s*eci ica""! stated and re.(ires a do""ar o(t"a!. -(t the cost o (sin$ retained earnin$s as a so(rce o ca*ita" is (nstated and has to %e i)*(ted. Ans&er 8-9 is incorrect %eca(se the cost o o%so"ete assets sho("d %e &ritten o . Ans&er 8C9 is incorrect %eca(se (nderstated de*reciation res("ts in (nstated costs. Ans&er 8D9 is incorrect %eca(se the "o&er1than1)ar,et ret(rn on a "oan is an i)*(ted cost o the *rod(cts. . REF;IRED6 The i)*"icit cost o inancin$. DISC;SSION6 8-9 De%t ca*ita" o ten a**ears to ha'e a "o&er cost than e.(it! %eca(se the i)*"icit costs are not o%'io(s. The i)*"icit costs are attri%(ta%"e to the increased ris, created %! the additiona" de%t %(rden. Th(sA as the de%t1to1e.(it! ratio increasesA the cost o %oth de%t and e.(it! &i"" increase $i'en the increased ris, to %oth shareho"ders and creditors ro) a hi$her de$ree o "e'era$e. An ex*"anation %ased on the )ar$ina" cost o ca*ita" and the )ar$ina" e icienc! o in'est)ent "eads to the sa)e conc"(sion. 5o&er cost ca*ita" so(rces are (sed irst. Additiona" *ro+ects )(st then %e (nderta,en &ith (nds ro) hi$her cost so(rces. Si)i"ar"!A ris, is increased %eca(se the )ost *ro ita%"e in'est)ents are )ade initia""!A "ea'in$ the "ess *ro ita%"e in'est)ents or the (t(re. Ans&er 8A9 is incorrect %eca(se %oth de%t and e.(it! so(rces increase in cost as "e'era$e increases. Ans&er 8C9 is incorrect %eca(se e.(it! costs dec"ine as "e'era$e decreases. Ans&er 8D9 is incorrect %eca(se the &ei$hted1a'era$e cost o ca*ita" &i"" increase &ith increased "e'era$e. . Retained earnin$s are +(st another or) o e.(it!. 0hen the co)*an! has retained earnin$sA the! can do one o t&o thin$s11rein'est the) or *a! the) o(t as di'idends. I the! rein'est the earnin$sA the! need to earn a ret(rn that is at "east as hi$h as the ,s o the stoc,. Other&iseA in'estors &o("d %e ha**ier $ettin$ the di'idends and in'estin$ the) in so)ethin$ that &i"" $et the) ,s. There oreA state)ent a is a"se. So)e o the *re erred stoc, di'idends are exc"(ded ro) taxation &hen another co)*an! o&ns the). It )a,es no tax di erence to the co)*an! that *a!s the di'idendsA since di'idends co)e o(t o a ter1tax do""ars. There oreA state)ent % is a"se. Interest *a!)ents are tax ded(cti%"e. There oreA state)ent c is tr(e. . Ans&er 8-9 is correct. The cost o de%t ca*ita" is si)*"! the de%t interest rate ti)es 81 1 the ir)Gs tax rate9. Th(sA i the tax rate is 4<JA the e ecti'e cost o de%t ca*ita" is =<J ti)es the interest rate %eca(se the interest is tax ded(cti%"e. See SMA 4AA Cost o Ca*ita". Ans&er 8A9 is incorrect %eca(se it i$nores the tax ded(cti%i"it! o interest *a!)ents. Ans&er 8C9 is incorrect %eca(se it i$nores the tax ded(cti%i"it! o interest *a!)ents. Ans&er 8D9 is incorrect %eca(se the ca*ita" asset *ricin$ )ode" is one )eans o deter)inin$ the cost o co))on e.(it!. . Ans&er 8D9 is correct. The a ter1tax cost o de%t is the cost o de%t ti)es the .(antit! one )in(s the tax rate. :or exa)*"eA the a ter1tax cost o a 1<J %ond is ?J M1<J x 81 1 7<J9N i the tax rate is 7<J.
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Ans&er 8A9 is incorrect %eca(se the a ter1tax cost o de%t is the cost o de%t ti)es the .(antit! one )in(s the tax rate. Ans&er 8-9 is incorrect %eca(se the a ter1tax cost o de%t is the cost o de%t ti)es the .(antit! one )in(s the tax rate. Ans&er 8C9 is incorrect %eca(se the cost o de%t ti)es the )ar$ina" tax rate e.(a"s the tax sa'in$s ro) iss(in$ de%t.
69
. Ans&er 8D9 is correct. -eca(se interest is ded(cti%"e or tax *(r*osesA the act(a" cost o de%t ca*ita" is the net e ect o the interest *a!)ent and the o settin$ tax ded(ction. The act(a" cost o de%t e.(a"s the interest rate ti)es one )in(s the )ar$ina" tax rate. Th(sA i a ir) &ith an DJ )ar,et rate is in a 4<J tax %rac,etA the net cost o the de%t ca*ita" is 4.DJ MDJ x 81 1 .49N. Ans&er 8A9 is incorrect %eca(se the tax ded(ction a"&a!s ca(ses the )ar,et !ie"d rate to %e hi$her than the cost o de%t ca*ita". Ans&er 8-9 is incorrect %eca(se additiona" de%t )a! or )a! not %e iss(ed )ore chea*"! than ear"ier de%tA de*endin$ (*on the interest rates in the )ar,et *"ace. Ans&er 8C9 is incorrect %eca(se the cost o de%t is "ess than the !ie"d rate $i'en that %ond interest is tax ded(cti%"e. . Ans&er 8C9 is correct. As a "ar$er *ro*ortion o an entit!Gs ca*ita" is *ro'ided %! de%tA the de%t %eco)es ris,ier and )ore ex*ensi'eA i.e.A re.(ires a hi$her interest rate. Ans&er 8A9 is incorrect %eca(se the di'ersit! decreasesA not increasesA ris,. Ans&er 8-9 is incorrect %eca(se W@< )i""ion is )in(sc("e in the de%t )ar,ets. Ans&er 8D9 is incorrect %eca(se the co)%ination a"ternati'e )aintains the sa)e de%tOe.(it! )ixt(reA &hich &o("d not &arrant a rate increase in the cost o de%t or e.(it!. . Ans&er 8C9 is correct. The excess o the *rice o'er the ace 'a"(e is a *re)i(). A *re)i() is *aid %eca(se the co(*on rate on the %ond is $reater than the )ar,et rate o interest. In other &ordsA %eca(se the %ond is *a!in$ a hi$her rate than other si)i"ar %ondsA its *rice is %id (* %! in'estors. Ans&er 8A9 is incorrect %eca(seA i a %ond se""s at a *re)i()A the )ar,et rate o interest is "ess than the co(*on rate. Ans&er 8-9 is incorrect %eca(se a %ond se""s at a disco(nt &hen the *rice is "ess than the ace a)o(nt. Ans&er 8D9 is incorrect %eca(se a %ond se""s at a disco(nt &hen the *rice is "ess than the ace a)o(nt. . REF;IRED6 The de inition o the )ar$ina" cost o de%t. DISC;SSION6 8C9 The )ar$ina" cost o de%t is ca"c("ated as the cost o ne& de%t ti)es one )in(s the )ar$ina" tax rateA or Kd 81 1 T9. This d ex*ression e.(a"s Kd 1 KdT . Ans&er 8A9 is incorrect %eca(se the )ar$ina" cost o de%t inancin$ is the interest rate on ne& de%t )in(s the ir)Gs )ar$ina" tax rate )("ti*"ied %! the interest rate. Ans&er 8-9 is incorrect %eca(se the )ar$ina" cost o de%t inancin$ is the interest rate on ne& de%t )in(s the ir)Gs )ar$ina" tax rate )("ti*"ied %! the interest rate. Moreo'erA the )ar$ina" or incre)enta" cost o de%t to the ir) is %ased on the cost o ne&"! iss(ed de%tA not on the cost o o(tstandin$ de%t. Ans&er 8D9 is incorrect %eca(se the )ar$ina" cost o de%t inancin$ is the interest rate on ne& de%t )in(s the ir)Gs )ar$ina" tax rate )("ti*"ied %! the interest rate. Moreo'erA the )ar$ina" or incre)enta" cost o de%t to the ir) is %ased on the cost o ne&"! iss(ed de%tA not on the cost o o(tstandin$ de%t. 3 The $e-t cost use$ to calculate a firmAs 6) is k$4: - T53 If k$ remains constant -ut T increasesB then the term 4: - T5 $ecreases an$ the (alue of the entire e#uationB k$4: - T5B $ecreases3 Statement - is falseC if a compan!As stock price increasesB an$ all else remains constantB then the $i(i$en$ !iel$ $ecreases an$ ks $ecreases3 This can -e seen from the e#uation ks 9 D:DP; = g3 Statement c is false for the same reason3 The cost of issuing new common stock is ke 9 D:DEP;4: - &5F = g3 If P; increases -ut thereAs no change in the flotation costB ke will $ecrease3 . Ans&er 8-9 is correct. 3ro'iders o e.(it! ca*ita" are ex*osed to )ore ris, than are "enders %eca(se the ir) is not o%"i$ated to *a! the) a ret(rn. A"soA in case o "i.(idationA creditors are *aid %e ore e.(it! in'estors. Th(sA e.(it! inancin$ is )ore ex*ensi'e than de%t %eca(se e.(it! in'estors re.(ire a hi$her ret(rn to co)*ensate or the $reater ris, ass()ed. Ans&er 8A9 is incorrect %eca(se the o%"i$ation to re*a! at a s*eci ic )at(rit! date red(ces the ris, to in'estors and th(s the re.(ired ret(rn. Ans&er 8C9 is incorrect %eca(se the de)and or e.(it! ca*ita" is direct"! re"ated to its $reater cost to the iss(er. Ans&er 8D9 is incorrect %eca(se di'idends are %ased on )ana$eria" discretion and )a! rare"! chan$eK interest ratesA ho&e'erA "(ct(ate dai"! %ased (*on )ar,et conditions.
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3 Statement a is correct3 Most preferre$ stock is owne$ -! corporations which recei(e a G; percent e'clusion of $i(i$en$s3 onse#uentl!B the -efore-ta' coupons on preferre$ stock are often lower than the -efore-ta' coupons on $e-tB $espite the fact that preferre$ stock is riskier than $e-t3 )ll the other statements are false3 . Ans&er 8-9 is correct. The di'idend $ro&th )ode" is (sed to ca"c("ate the *rice o stoc,.
76
)o *
D1 +,-
I 6 3O S c(rrent *rice D1 S next di'idend R S re.(ired rate o ret(rn G S E3S $ro&th rate Ass()in$ that D1 and G re)ain constantA an increase in R res("tin$ ro) an increase in the no)ina" interest rate &i"" ca(se 3O to decrease. Ans&er 8A9 is incorrect %eca(se a hi$her interest rate raises the re.(ired ret(rn o in'estorsA &hich res("ts in a "o&er stoc, *rice. Ans&er 8C9 is incorrect %eca(se a hi$her interest rate raises the re.(ired ret(rn o in'estorsA &hich res("ts in a "o&er stoc, *rice. Ans&er 8D9 is incorrect %eca(se a hi$her interest rate raises the re.(ired ret(rn o in'estorsA &hich res("ts in a "o&er stoc, *rice.
77
. REF;IRED6 The ite) res("tin$ in a hi$her )ar,et 'a"(e or co))on shares. DISC;SSION6 8A9 The di'idend $ro&th )ode" is (sed to ca"c("ate the cost o e.(it!. The si)*"i ied or)("a is
+*
D .) D +,-
R is the re.(ired rate o ret(rnA D is the next di'idendA 3 is the stoc,Cs *riceA and G is the $ro&th rate in earnin$s *er share. The e.(ation is a"so (sed to deter)ine the stoc, *rice.
)*
Th(sA &hen in'estors ha'e a "o&er re.(ired ret(rn on e.(it!A the deno)inator is s)a""erA &hich trans"ates in to a hi$her )ar,et 'a"(e. Ans&er 8-9 is incorrect %eca(seA i in'estors ex*ect "o&er di'idend $ro&thA the )ar,et 'a"(e o co))on shares &i"" decrease. Ans&ers 8C9 and 8D9 are incorrect %eca(se the ex*ected ho"din$ *eriods o in'estors are not re"ated to the )ar,et 'a"(e o the co))on shares.
78
. Ans&er 8-9 is correct. Ne&"! iss(ed or externa" co))on e.(it! is )ore cost"! than retained earnin$s. The co)*an! inc(rs iss(ance costs &hen raisin$ ne&A o(tside (nds. Ans&er 8A9 is incorrect %eca(se the cost o retained earnin$s is the rate o ret(rn stoc,ho"ders re.(ire on e.(it! ca*ita" the ir) o%tains %! retainin$ earnin$s. The o**ort(nit! cost o retained (nds &i"" %e *ositi'e. Ans&er 8C9 is incorrect %eca(se retained earnin$s &i"" a"&a!s %e "ess cost"! than externa" e.(it! inancin$. Earnin$s retention does not re.(ire the *a!)ent o iss(ance costs. Ans&er 8D9 is incorrect %eca(se retained earnin$s &i"" a"&a!s %e "ess cost"! than externa" e.(it! inancin$. Earnin$s retention does not re.(ire the *a!)ent o iss(ance costs. 3 Statement a is correctC the other statements are false3 Preferre$ stock $i(i$en$s are not ta' $e$ucti-leC thereforeB the cost of preferre$ stock is onl! kp3 The risk premium in the -on$-!iel$-plus-risk premium approach woul$ -e a$$e$ to the firmAs cost of $e-tB not the risk-free rate3 Preferre$ stock also has flotation costs3 . REF;IRED6 The e ect o a hi$her di'idend1*a!o(t ratio. DISC;SSION6 8A9 the hi$her the di'idend1*a!o(t ratioA the sooner retained earnin$s are exha(sted and the co)*an! )(st see, externa" inancin$. Ass()in$ the sa)e in'est)ents are (nderta,enA the res("t is a hi$her )ar$ina" cost o ca*ita" %eca(se "o&er1cost ca*ita" so(rces &i"" %e (sed (* ear"ier. Ans&er 8-9 is incorrect %eca(se the )ar$ina" cost o ca*ita" is hi$her. Ans&ers 8C9 and 8D9 are incorrect %eca(se the existence o in'est)ent o**ort(nities is (nre"ated to the di'idend *a!o(t.
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81
. Ans&er 8D9 is correct. The )ar$ina" cost o ca*ita" is the cost o the next do""ar o ca*ita". The )ar$ina" cost contin(a""! increases %eca(se the "o&er cost so(rces o (nds are (sed irst. The )ar$ina" cost re*resents a &ei$hted a'era$e o %oth de%t and e.(it! ca*ita". Ans&er 8A9 is incorrect %eca(seA i the cost o ca*ita" &ere the sa)e as the rate o ret(rn on e.(it! 8&hich is (s(a""! hi$her than that o de%t ca*ita"9A there &o("d %e no incenti'e to in'est. Ans&er 8-9 is incorrect %eca(se the )ar$ina" cost o ca*ita" is a ected %! the de$ree o de%t in the ir)Gs ca*ita" str(ct(re. :inancia" ris, *"a!s a ro"e in the ret(rns desired %! in'estors. Ans&er 8C9 is incorrect %eca(se the rate o ret(rn (sed or ca*ita" %(d$etin$ *(r*oses sho("d %e at "east as hi$h as the )ar$ina" cost o ca*ita". . Ans&er 8-9 is correct. The )eas(re o the 'a"(e o an indi'id(a" stoc, is de*endent entire"! (*on the strea) o (t(re cash "o&s that it &i"" *rod(ce. To deter)ine the stoc,Gs c(rrent 'a"(eA these cash "o&s sho("d %e disco(nted to ti)e #ero 8no&9 to o%tain the strea)Gs *resent 'a"(e. Stoc,s *ri)ari"! *ro'ide cash "o&s to in'estors 'ia di'idends 8inc"(din$ share re*(rchases and "i.(idatin$ di'idends9 and ca*ita" $ain 8"oss9 at the ti)e o sa"e. Once the strea) o cash "o&s has %een disco(nted o'er a si$ni icant n()%er o *eriodsA it is eas! to see that the di'idend strea)A not the ca*ita" $ain 8"oss9 in the ina" *eriodA dri'es the 'a"(e o the stoc, in .(estion. O co(rseA a"" ir)s do not *a! a di'idend. Co))on inancia" theor!A ho&e'erA states that it is the intention o e'er! ir) to *a! a di'idend to shareho"ders at so)e ti)e in the (t(reA once the ir) ee"s it is stron$ eno($h to do so and sti"" s(**ort (t(re o*erations. A ter a""A it is the *ri)ar! $oa" o a ir)Gs )ana$e)ent to )axi)i#e shareho"der &ea"th. A"tho($h )an! actors sho("d %e considered &hen *(rchasin$ a sec(rit!A the *ri)ar! consideration or a 'a"(e1see,in$ in'estor is the (t(re cash "o& strea). Ans&er 8A9 is incorrect %eca(se %oo, 'a"(e is a )eas(re o the stoc,Gs &orth on a co)*an!Gs acco(ntin$ records. Ans&er 8C9 is incorrect %eca(se the %eta coe icient is a )eas(re o ho& 'o"ati"e the *rice )o'e)ents o a stoc, are re"ati'e to the )ar,et as a %ench)ar,. Ans&er 8D9 is incorrect %eca(se standard de'iation is a )eas(re o ris,. 0hi"e ris, is a consideration or the in'estorA one o the (nda)enta" conce*ts in inance is that there is 8sho("d %e9 a trade1o %et&een ris, and ret(rnA and as "on$ as ris, is co)*ensated orA it is not a *ri)ar! consideration. . Ans&er 8D9 is correct. The di'idend $ro&th )ode" is (sed to ca"c("ate the cost o e.(it!. The si)*"i ied or)("a is D1 RS QG )% R is the re.(ired rate o ret(rnA D1 is the next di'idendA 3O is the stoc,Gs *riceA and G is the $ro&th rate in earnin$s *er share. The e.(ation is a"so (sed to deter)ine the stoc, *rice.
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)o *
D1 +,-
Ans&er 8A9 is incorrect %eca(se the )ode" (ses the $ro&th rate in di'idends and the in'estorGs re.(ired rate o ret(rn. Ans&er 8-9 is incorrect %eca(se the )ode" (ses the $ro&th rate in di'idends and the in'estorGs re.(ired rate o ret(rn. Ans&er 8C9 is incorrect %eca(se the )ode" (ses the $ro&th rate in di'idends and the in'estorGs re.(ired rate o ret(rn.
84
. Ans&er 8D9 is correct. The Gordon 8di'idend9 $ro&th )ode" re.(ires three e"e)ents to esti)ate the cost o e.(it! ca*ita". These are the di'idends *er shareA the ex*ected $ro&th rate in di'idends *er shareA and the )ar,et *rice o the stoc,. -asica""!A the cost o e.(it! ca*ita" can %e co)*(ted as the di'idend !ie"d 8di'idends X *rice9 *"(s the $ro&th rate. Ans&er 8A9 is incorrect %eca(se %oo, 'a"(e *er share is not a consideration in co)*(tin$ the cost o e.(it! ca*ita". Ans&er 8-9 is incorrect %eca(se c(rrent di'idendsA not c(rrent earnin$sA *er share are a re.(ire)ent or the or)("a. Ans&er 8C9 is incorrect %eca(se %oo, 'a"(e *er share is not a consideration in co)*(tin$ the cost o e.(it! ca*ita". A"soA c(rrent di'idendsA not c(rrent earnin$sA *er share are a re.(ire)ent or the or)("a. 3 The )PM assumes that in(estors are price-takers with the same single hol$ing perio$ an$ that there are no ta'es or transaction costs3 . The SM5 is a )eas(re o ex*ected ret(rn *er (nit o ris,A &here ris, is de ined as %eta 8s!ste)atic ris,9.
D@
D=
D?
. The SM5 is a )eas(re o ex*ected ret(rn1%eta 8the CM5 is a )eas(re o ex*ected ret(rn1standard de'iation o )ar,et ret(rns9. The SM5 *ro'ides the ex*ected ret(rn1%eta re"ationshi* or P air"! *ricedP sec(ritiesK th(s i a *ort o"io
)ana$er se"ects sec(rities that are (nder*riced and *rod(ces a *ort o"io &ith a *ositi'e a"*haA this *ort o"io )ana$er &o("d recei'e a *ositi'e e'a"(ation.
88
. -oth the Ca*ita" Mar,et 5ine and the Sec(rit! Mar,et 5ine de*ict ris,Oret(rn re"ationshi*s. Bo&e'erA the ris, )eas(re or the CM5 is standard de'iation and the ris, )eas(re or the SM5 is %eta 8th(s c is not tr(eK the other state)ents are tr(e9. . In e.(i"i%ri()A the )ar$ina" *rice o ris, or a ris,! sec(rit! )(st %e e.(a" to the )ar$ina" *rice o ris, or the )ar,et. I notA in'estors &i"" %(! or se"" the sec(rit! (nti" the! are e.(a". . An (nder*riced sec(rit! &i"" ha'e a hi$her ex*ected ret(rn than the SM5 &o("d *redictK there ore it &i"" *"ot a%o'e the SM5. . Ans&er 8A9 is correct. The ca*ita" asset *ricin$ )ode" adds the ris,1 ree rate to the *rod(ct o the )ar,et ris, *re)i() and the %eta coe icient. The )ar,et ris, *re)i() is the a)o(nt a%o'e the ris,1 ree rate 8a**roxi)ated %! the ;.S. treas(r! %ond !ie"d9 that )(st %e *aid to ind(ce in'est)ent in the )ar,et. The %eta coe icient o an indi'id(a" stoc, is the corre"ation %et&een the *rice 'o"ati"it! o the stoc, )ar,et as a &ho"e and the *rice 'o"ati"it! o the indi'id(a" stoc,. Ans&er 8-9 is incorrect %eca(se the *rice1earnin$s ratio is not a co)*onent o the )ode". Ans&er 8C9 is incorrect %eca(se the *rice1earnin$s ratio is not a co)*onent o the )ode". Ans&er 8D9 is incorrect %eca(se the di'idend *a!o(t ratio is not a co)*onent o the )ode". . The ex*ected rate o ret(rn on an! sec(rit! is e.(a" to the ris, ree rate *"(s the s!ste)atic ris, o the sec(rit! 8%eta9 ti)es the )ar,et ris, *re)i()A E8rM 1 R 9. . The tan$enc! *oint %et&een the ca*ita" )ar,et "ine and the indi erence c(r'e is the o*ti)a" *ort o"io or a *artic("ar in'estor. . A #ero a"*ha res("ts &hen the sec(rit! is in e.(i"i%ri() 8 air"! *riced or the "e'e" o ris,9.
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. A sec(rit! &ith a *ositi'e a"*ha is one that is ex*ected to !ie"d an a%nor)a" rate o ret(rnA %ased on the *ercei'ed ris, o the sec(rit!A and th(s is (nder*riced. . Ans&er 8-9 is correct. The re.(ired rate o ret(rn on e.(it! ca*ita" in the Ca*ita" Asset 3ricin$ Mode" is the ris,1 ree rate 8deter)ined %! $o'ern)ent sec(rities9A *"(s the *rod(ct o the )ar,et ris, *re)i() ti)es the %eta coe icient 8%eta )eas(res the ir)Gs ris,9. The )ar,et ris, *re)i() is the a)o(nt a%o'e the ris,1 ree rate that &i"" ind(ce in'est)ent in the )ar,et. The %eta coe icient o an indi'id(a" stoc, is the corre"ation %et&een the 'o"ati"it! 8*rice 'ariation9 o the stoc, )ar,et and that o the *rice o the indi'id(a" stoc,. :or exa)*"eA i an indi'id(a" stoc, $oes (* 1@J and the )ar,et on"! 1<JA %eta is 1.@. Ans&er 8A9 is incorrect %eca(se the coe icient o 'ariation co)*ares ris, &ith ex*ected ret(rn 8standard de'iation X ex*ected ret(rn9. Ans&er 8C9 is incorrect %eca(se standard de'iation )eas(res dis*ersion 8ris,9 o *ro+ect ret(rns. Ans&er 8D9 is incorrect %eca(se ex*ected ret(rn does not descri%e ris,. . Ans&er 8A9 is correct. The &ord %eta is deri'ed ro) the re$ression e.(ation or re$ressin$ the ret(rn o an indi'id(a" sec(rit! 8the de*endent 'aria%"e9 to the o'era"" )ar,et ret(rn. The %eta coe icient is the s"o*e o the re$ression "ine. The %eta or a sec(rit! )a! a"so %e ca"c("ated %! di'idin$ the co'ariance o the ret(rn on the )ar,et and the ret(rn on the sec(rit! %! the 'ariance o the ret(rn on the )ar,et. Ans&er 8-9 is incorrect %eca(se %eta e.(a"s the co'ariance o the ret(rns on the )ar,et and on the sec(rit! di'ided %! the 'ariance o the ret(rn on the )ar,et. Ans&er 8C9 is incorrect %eca(se %eta e.(a"s the co'ariance o the ret(rns on the )ar,et and on the sec(rit! di'ided %! the 'ariance o the ret(rn on the )ar,et. Ans&er 8D9 is incorrect %eca(se %eta e.(a"s the co'ariance o the ret(rns on the )ar,et and on the sec(rit! di'ided %! the 'ariance o the ret(rn on the )ar,et.
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. Ans&er 8C9 is correct. The re"e'ant ris, o a sec(rit! is its contri%(tion to the *ort o"ioGs ris,. It is the ris, that cannot %e e"i)inated thro($h di'ersi ication and is s!non!)o(s &ith )ar,et ris, and s!ste)atic ris,. The re"e'ant ris, res("ts ro) actorsA s(ch as in "ationA recessionA and hi$h interest ratesA that a ect a"" stoc,s. Ans&er 8A9 is incorrect %eca(se co)*an!1s*eci ic ris, can %e e"i)inated thro($h *ort o"io di'ersi ication. Ans&er 8-9 is incorrect %eca(se di'ersi ia%"e ris, can %e e"i)inated thro($h *ort o"io di'ersi ication. Ans&er 8D9 is incorrect %eca(se on"! the s!ste)atic co)*onent o tota" ris, is re"e'ant to sec(rit! 'a"(ation. . . . . -eta is a )eas(re o ho& a sec(rit!Gs ret(rn co'aries &ith the )ar,et ret(rnsA nor)a"i#ed %! the )ar,et 'ariance. -! de initionA the %eta o the )ar,et *ort o"io is 1. OnceA a *ort o"io is di'ersi iedA the on"! ris, re)ainin$ is s!ste)atic ris,A &hich is )eas(red %! %eta. E8RS9 S r Q <8RM 1 r 9 S r .
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1<<
1<1
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. The )ar,et re&ards s!ste)atic ris,A &hich is )eas(red %! %etaA and th(sA the ris, *re)i() on a stoc, or *ort o"io 'aries direct"! &ith %eta. . The ris, *re)i() on the )ar,et *ort o"io is *ro*ortiona" to the a'era$e de$ree o ris, a'ersion o the in'estor *o*("ation and the ris, o the )ar,et *ort o"io )eas(red %! its 'ariance. alculate the re#uire$ returnB ksB an$ use to calculate the 6) H ,s S 1<J Q 1.7D8@J9 S 1=.>J. 0ACC S <.@81/.<J98<.=9 Q <.@81=.>J9 S 1/.<@J. Co)*are ex*ected *ro+ect ret(rnA k Project A to 0ACC6 k -(t Project S IRR S 17.<J. Acce*t the *ro+ect since IRR3ro+ect T 0ACC6 17.<J T 1/.<@J. . Ans&er 8-9 is correct. To esti)ate the re.(ired rate o ret(rn on e.(it!A the ca*ita" asset *ricin$ )ode" 8CA3M9 adds the ris,1 ree rate 8deter)ined %! $o'ern)ent sec(rities9 to the *rod(ct o the %eta coe icient 8a )eas(re o the ir)Gs ris,9 and the di erence %et&een the )ar,et ret(rn and the ris,1 ree rate. -e"o& is the %asic e.(i"i%ri() e.(ation or the CA3M. R S R: Q ] 8RM 1 R: 9 Th(sA $i'en a %eta o 1./A R is 11J M@J Q 1./ 81<J 1 @J9N. At a %eta o 1.@A R is 1/.@J M@J Q 1.@ 81<J 1 @J9N. Ans&er 8A9 is incorrect %eca(se 7J e.(a"s the )ar,et ret(rn ti)es the increase in the %eta. Ans&er 8C9 is incorrect %eca(se the co)*an!Gs re.(ired rate o ret(rn is a ected %! a chan$e in the co)*an!Gs %eta coe icient. Ans&er 8D9 is incorrect %eca(se the chan$e res("ts in an increase o the co)*an!Gs re.(ired rate o ret(rnA not a decrease. . . .
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11J S @J Q 1.@8>J 1 @J9 S 11.<JK there oreA the sec(rit! is air"! *riced. 1/J U ?J Q 1.781@J 1 ?J9 S 1?.4<JK there oreA stoc, is o'er*riced and sho("d %e shorted. A61/J 1 M@J Q 1./8>J 1 @J9N S /./J.
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%ecause corporations can e'clu$e $i(i$en$s for ta' purposesB preferre$ stock often has a -efore-ta' market return that is less than the issuing compan!As -efore-ta' cost of $e-t3 ThenB if the issuerAs ta' rate is IeroB its component cost of preferre$ woul$ -e less than its after-ta' cost of $e-t3 . Ans&er 8-9 is correct. The cost o ca*ita" o a ir) is the c(rrentA &ei$hted a'era$eA a ter1tax cost o the ir)Gs 'ario(s inancin$ co)*onents. Bistorica" costs are irre"e'ant. Ans&er 8A9 is incorrect %eca(se the cost o ca*ita" is a &ei$hted a'era$e or a"" so(rces o ca*ita". Ans&er 8C9 is incorrect %eca(se costs are considered a ter taxes. :or exa)*"eA the ded(cti%i"it! o interest )(st %e considered. Ans&er 8D9 is incorrect %eca(se the ti)e 'a"(e o )one! sho("d %e incor*orated into the ca"c("ations.
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. Ans&er 8D9 is correct. A &ei$hted a'era$e o the costs o a"" inancin$ so(rces sho("d %e (sedA &ith the &ei$hts deter)ined %! the (s(a" inancin$ *ro*ortions. The ter)s o an! inancin$ raised at the ti)e o initiatin$ a *artic("ar *ro+ect do not re*resent the cost o ca*ita" or the ir). 0hen a ir) achie'es its o*ti)a" ca*ita" str(ct(reA the &ei$hted1 a'era$e cost o ca*ita" is )ini)i#ed. Ans&er 8A9 is incorrect %eca(se the cost o ca*ita" is a co)*ositeA or &ei$hted a'era$eA o a"" inancin$ so(rces in their (s(a" *ro*ortions. The cost o ca*ita" sho("d a"so %e ca"c("ated on an a ter1tax %asis. Ans&er 8-9 is incorrect %eca(se the cost o ca*ita" is a co)*ositeA or &ei$hted a'era$eA o a"" inancin$ so(rces in their (s(a" *ro*ortions. The cost o ca*ita" sho("d a"so %e ca"c("ated on an a ter1tax %asis. Ans&er 8C9 is incorrect %eca(se the cost o ca*ita" is a co)*ositeA or &ei$hted a'era$eA o a"" inancin$ so(rces in their (s(a" *ro*ortions. The cost o ca*ita" sho("d a"so %e ca"c("ated on an a ter1tax %asis. . Ans&er 8A9 is correct. The cost o ca*ita" o a ir) is the c(rrentA &ei$hted1a'era$eA a ter1tax cost o the ir)Gs 'ario(s inancin$ co)*onents. Bistorica" costs are irre"e'ant. Ans&er 8-9 is incorrect %eca(se costs are considered a ter taxes. :or exa)*"eA the ded(cti%i"it! o interest )(st %e considered. Ans&er 8C9 is incorrect %eca(se the ti)e 'a"(e o )one! sho("d %e incor*orated into the ca"c("ations. Ans&er 8D9 is incorrect %eca(se the cost o ca*ita" is a &ei$hted a'era$e or a"" so(rces o ca*ita". 3 If a firm pai$ no income ta'esB its cost of $e-t woul$ not -e a$7uste$ $ownwar$B hence the component cost of $e-t woul$ -e higher than if T were greater than ;3 6ith a higher component cost of $e-tB the 6) woul$ -e increase$3 ,f courseB the compan! woul$ ha(e higher earningsB an$ its cash flows from a gi(en pro7ect woul$ -e highB so the higher 6) woul$ not impe$e its in(estmentsB that isB its capital -u$get woul$ -e larger than if it were ta'e$3 3 Statements a an$ c are -oth correctC thereforeB statement $ is the correct choice3 Statement a recites the $efinition of the weighte$ a(erage cost of capital3 Statement c is correct -ecause k$ 9 kR& = "P = MRP = DRP while ks 9 kR& = 4kM - kR&5-3 If kR& increases then the (alues for k$ an$ ks will increase3 . State)ent a is correctK the other state)ents are a"se. State)ent % is incorrectK 0ACC is an a'era$e o de%t and e.(it! inancin$. Since de%t inancin$ is chea*er and is ad+(sted do&n&ard or taxesA it sho("dA &hen a'era$ed &ith e.(it!A ca(se the 0ACC to %e "ess than the cost o e.(it! inancin$. State)ent c is incorrectK 0ACC is ca"c("ated on an a ter1tax %asis. State)ent d is incorrectK the 0ACC is %ased on )ar$ina"A not e)%eddedA costs. State)ent e is incorrectK the cost o iss(in$ ne& co))on stoc, is $reater than the cost o retained earnin$s. . 0ACC )eas(res the )ar$ina" a ter1tax cost o ca*ita"K there oreA state)ent a is a"se. The a ter1tax cost o de%t inancin$ is "ess than the a ter1tax cost o e.(it! inancin$K there oreA state)ent % is a"se. The correct choice is state)ent c. . The *re erred stoc, di'idend is not tax ded(cti%"e "i,e the interest *a!)ent on de%t. There oreA there is no tax %ene it ro) *re erred stoc,. State)ent a is tr(e. Retained earnin$s are e.(it!A and e.(it! &i"" ha'e a hi$her cost than de%t. There oreA state)ent % is a"se. I the %eta increasesA in'estors &i"" re.(ire a hi$her rate o ret(rn to ho"d or %(! the stoc,. There oreA the cost o e.(it! &i"" $o (*A and state)ent c is tr(e. -eca(se state)ents a and c are tr(eA the correct choice is state)ent e. 3 Statements a an$ - are true3 Statement c is false3 The cost of new stock is higher than the cost of retaine$ earnings -ecause there are flotation costs associate$ with issuing new stock3 Since statements a an$ - are true the correct choice is statement $3 3 Statement c is the correct choice3 ) ta' rate increase woul$ lea$ to a $ecrease in the after-ta' cost of $e-t an$B conse#uentl!B the firmAs 6) woul$ $ecrease3 3 Statement a is correctC the other statements are false3 If RPM $ecreasesB the cost of e#uit! will -e re$uce$3 )nswers - through e will all increase the compan!As 6) 3
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s 3 alculate the re#uire$ returnB ksB an$ compare to the e'pecte$ returnB k s S ?J. k ,s S ,R: Q 8,M 1 ,R:9% S <.<? Q 8<.1< 1 <.<?9<.@ S <.<D@ S D.@J. s K D.@J T ?.<JK re+ect the in'est)ent. ,s T k 3 alculate the re#uire$ returnB ksB an$ use to calculate the 6) H ,s S 1<J Q 1.7D8@J9 S 1=.>J. 0ACC S <.@81/.<J98<.=9 Q <.@81=.>J9 S 1/.<@J. project A to 0ACC6 Co)*are ex*ected *ro+ect ret(rnA k project S 17.<J. -(t k project T 0ACC6 17.<J T 1/.<@J. Acce*t the *ro+ect since k
1/4
alculate the after-ta' component cost of $e-t as :;<4: - ;3J5 9 G<3 If the compan! has earnings of K:;;B;;; an$ pa!s out ?;< or K?;B;;; in $i(i$en$sB then it will retain earnings of K?;B;;;3 The retaine$ earnings -reakpoint is K?;B;;;D;3L 9 K:M?B;;;3 Since it will re#uire financing in e'cess of K:M?B;;; to un$ertake an! of the alternati(esB we can conclu$e the firm must issue new e#uit!3 ThereforeB the pertinent component cost of e#uit! is the cost of new e#uit!3 alculate the e'pecte$ $i(i$en$ per share 4note this is D:5 as K?;B;;;D:;B;;; 9 K?3 ThusB the cost of new e#uit! is K?DE4KJ?4: - ;3:M5F = >< 9 MM3MJ<3 1acksonAs 6) is G<4;3>5 = MM3MJ<4;3L5 9 :J3;@<3 ,nl! the return on Pro7ect ) e'cee$s the 6) B so onl! Pro7ect ) will -e un$ertaken3 . Ans&er 8C9 is correct. The de$ree o o*eratin$ "e'era$e is the *ercenta$e chan$e in E-IT res("tin$ ro) a $i'en *ercenta$e chan$e in sa"es. Th(sA it ca(ses E-IT to %e )ore sensiti'e to chan$es in sa"es. Ans&er 8A9 is incorrect %eca(se the ter) credit is not a**"ica%"e to "e'era$e. Ans&er 8-9 is incorrect %eca(se inancia" "e'era$e re ers to the sensiti'it! o E3S to E-IT. Ans&er 8D9 is incorrect %eca(se the ter) intrinsic is not a**"ica%"e to "e'era$e. . Ans&er 8A9 is correct. O*eratin$ "e'era$e is %ased on the de$ree to &hich ixed costs are (sed in *rod(ction. :ir)s )a! increase ixed costsA s(ch as %! a(to)ationA to red(ce 'aria%"e costs. The res("t is a $reater de$ree o o*eratin$ "e'era$e 8DO59A &hich is the *ercenta$e chan$e in earnin$s %e ore interest and taxes 8net o*eratin$ *ro it9 di'ided %! the *ercenta$e chan$e in (nit sa"es. It can a"so %e deter)ined ro) the o""o&in$ or)("aA $i'en that F is .(antit! o (nits so"dA 3 is (nit *riceA V is (nit 'aria%"e costA and : is ixed cost6 0$) , &" 0$) , &" , / Ans&er 8-9 is incorrect %eca(se the de$ree o inancia" "e'era$e e.(a"s the *ercenta$e chan$e in E3S di'ided %! the *ercenta$e chan$e in net o*eratin$ *ro it. Ans&er 8C9 is incorrect %eca(se the %rea,e'en *oint is the sa"es 'o"()e at &hich tota" re'en(e e.(a"s tota" costs. Ans&er 8D9 is incorrect %eca(se the de$ree o tota" 8co)%ined9 "e'era$e e.(a"s the *ercenta$e chan$e in E3S di'ided %! the *ercenta$e chan$e in sa"es. . Ans&er 8C9 is correct. The de$ree o o*eratin$ "e'era$e 8DO59 is a )eas(re o the chan$e in earnin$s a'ai"a%"e to co))on stoc,ho"ders associated &ith a $i'en chan$e in o*eratin$ earnin$s. It is ca"c("atedA or a *artic("ar "e'e" o sa"esA as6
sa5es re4en6e , 4ariab5e 1osts sa5es re4en6e , 4ariab5e 1osts , fi!e3 operatin2 1osts
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Ans&er 8A9 is incorrect %eca(se DO5 'aries &ith the sa"es "e'e". Ans&er 8-9 is incorrect %eca(se the de$ree o inancia" "e'era$e is a )eas(re o the chan$e in earnin$s a'ai"a%"e to co))on stoc,ho"ders associated &ith a $i'en chan$e in o*eratin$ earnin$s. Ans&er 8D9 is incorrect %eca(se the de$ree o tota" "e'era$e is the )("ti*"e o the de$ree o o*eratin$ "e'era$e and the de$ree o inancia" "e'era$e. Other thin$s %ein$ e.(a"A DO5 is hi$her i the de$ree o tota" "e'era$e is hi$her.
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. Ans&er 8A9 is correct. The de$ree o o*eratin$ "e'era$e 8DO59 is e.(a" to the *ercenta$e chan$e in net o*eratin$ inco)eA that isA earnin$s %e ore interest and taxes 8E-IT9 di'ided %! the *ercenta$e chan$e in sa"es. -eca(se interest ex*enses are not inc"(ded in E-ITA the DO5 is not a ected %! a chan$e in interest ex*ense. Ans&er 8-9 is incorrect %eca(se 'aria%"e cost *er (nit a ects E-IT and there ore the DO5. Ans&er 8C9 is incorrect %eca(se .(antit! o (nits so"d a ects E-IT and there ore the DO5. Ans&er 8D9 is incorrect %eca(se ixed costs a ect E-IT and there ore the DO5. . Ans&er 8-9 is correct. O*eratin$ "e'era$e is a )eas(re o the de$ree to &hich ixed costs are (sed in the *rod(ction *rocess. A co)*an! &ith a hi$her *ercenta$e o ixed costs 8hi$her o*eratin$ "e'era$e9 has $reater ris, than one in the sa)e ind(str! that re"ies )ore hea'i"! on 'aria%"e costs. The DO5 e.(a"s the *ercenta$e chan$e in net o*eratin$ inco)e di'ided %! the *ercenta$e chan$e in sa"es. Th(sA *ro its %eca)e )ore sensiti'e to chan$es in sa"es 'o"()e as the DO5 increases. Ans&er 8A9 is incorrect %eca(se a ir) &ith hi$her o*eratin$ "e'era$e has hi$her ixed costs and "o&er 'aria%"e costs. Ans&er 8C9 is incorrect %eca(se a ir) &ith hi$her "e'era$e &i"" %e re"ati'e"! )ore *ro ita%"e than a ir) &ith "o&er "e'era$e &hen sa"es are hi$h. The o**osite is tr(e &hen sa"es are "o&. Ans&er 8D9 is incorrect %eca(se a ir) &ith hi$her "e'era$e is )ore ris,!. Its re"iance on ixed costs is $reater. . Ans&er 8-9 is correct. A *(rchase o treas(r! stoc, in'o"'es a decrease in assets 8(s(a""! cash9 and a corres*ondin$ decrease in shareho"dersG e.(it!. Th(sA e.(it! is red(ced and the de%t1to1e.(it! ratio and inancia" "e'era$e increase. Ans&er 8A9 is incorrect %eca(se assets decrease &hen treas(r! stoc, is *(rchased. Ans&er 8C9 is incorrect %eca(se a ir)Gs interest co'era$e ratio is (na ected. Earnin$sA interest ex*enseA and taxes &i"" a"" %e the sa)e re$ard"ess o the transaction. Ans&er 8D9 is incorrect %eca(se the *(rchase o treas(r! stoc, is antidi"(ti'eK the sa)e earnin$s &i"" %e s*read o'er e&er shares. So)e ir)s *(rchase treas(r! stoc, or this reason. . REF;IRED6 The e ect o increasin$ the D:5. DISC;SSION6 8D9 The D:5 e.(a"s the *ercenta$e chan$e in earnin$s a'ai"a%"e to co))on shareho"ders di'ided %! the *ercenta$e chan$e in net o*eratin$ inco)e. 0hen the D:5 risesA ixed interest char$es and the ris,iness o the ir) rise. As a res("tA the 'aria%i"it! o the ret(rns to e.(it! ho"ders &i"" increase. In other &ordsA the standard de'iation o ret(rns on the e.(it! o the co)*an! rises. Ans&er 8A9 is incorrect %eca(se an increase in the D:5 increases the ris,iness o the ir)Cs stoc,. Th(sA %eta rises. -eta is a )eas(re o the 'o"ati"it! o a ir)Cs stoc, *rice re"ati'e to the a'era$e stoc,. Ans&ers 8-9 and 8C9 are incorrect %eca(se s!ste)atic ris,A a"so ,no&n as )ar,et ris,A is (nre"ated to the D:5. S!ste)atic ris, is not s*eci ic to a co)*an!. It is the ris, associated &ith a co)*an!Cs stoc, that cannot %e di'ersi ied %eca(se it arises ro) actors that a ect a"" stoc,s. . Ans&er 8C9 is correct. :inancia" "e'era$e is the (se o %orro&ed )one! to earn )one! or the %ene it o shareho"ders. The ex*ectation is that in'est)ent earnin$s &i"" %e $reater than the interest *aid on the %orro&ed (nds. Increasin$ de%t 8s(ch as %onds9 increases inancia" "e'era$e. Ans&er 8A9 is incorrect %eca(se the iss(ance o co))on stoc, does not increase inancia" "e'era$e. No increase in %orro&ed ca*ita" and ixed interest char$es occ(rs &hen e.(it! is iss(ed. Ans&er 8-9 is incorrect %eca(se a decrease in the di'idend *a!o(t ratio &o("d res("t in increased o&nersG e.(it! 8retained earnin$s9A and &o("d not increase de%t ca*ita" and inancia" "e'era$e. Ans&er 8D9 is incorrect %eca(se (sin$ de%tA not e.(it!A (nds to inance ne& in'est)ents increases inancia" "e'era$e. . Ans&er 8C9 is correct. Earnin$s *er share is "ess 'o"ati"e in "ess hi$h"! "e'era$ed ir)s. 5o&er ixed costs res("t in "ess 'aria%"e earnin$s &hen sa"es "(ct(ate. Ans&er 8A9 is incorrect %eca(se hi$her "e'era$e is associated &ith hi$herA not "o&erA E3S &hen sa"es exceed the %rea,e'en *oint. Ans&er 8-9 is incorrect %eca(se earnin$s *er share is )ore 'o"ati"e in )ore hi$h"! "e'era$ed ir)s. Ans&er 8D9 is incorrect %eca(se "ess "e'era$e is associated &ith "o&erA not hi$herA E3S &hen sa"es exceed the %rea,e'en *oint.
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133
134
. Ans&er 8-9 is correct. :inancia" "e'era$e is the a)o(nt o the ixed cost o ca*ita"A *rinci*a""! de%tA in a ir)Gs ca*ita" str(ct(re re"ati'e to its o*eratin$ *ro it. 5e'era$e creates inancia" ris, and is direct"! re"ated to the cost o ca*ita". -eca(se the co)*an! is retirin$ %ondsA the tota" de%t is decreased. Gi'en that the a)o(nt o de%t and "e'era$e are direct"! re"atedA a decrease in the a)o(nt o de%t res("ts in a decrease in inancia" "e'era$e. Ans&er 8A9 is incorrect %eca(se the %ond retire)ent decreases the de%t1e.(it! ratio. Ans&er 8C9 is incorrect %eca(se the tota" assets &i"" decrease 8assets &i"" %e (sed to retire the de%tA res("tin$ in an increased asset t(rno'er ratio 8net sa"es X a'era$e tota" assets9. Ans&er 8D9 is incorrect %eca(se the interest ex*ense a'oided &i"" increase net *ro it and the ret(rn on shareho"dersG e.(it!. . State)ent a is tr(eK a hi$her E3S does not a"&a!s )ean that the stoc, *rice &i"" increase. State)ent % is a"seK a "o&er 0ACC &i"" )ean a hi$her stoc, *rice. State)ent c is a"seK E3S can increase +(st %eca(se shares o(tstandin$ dec"ine. . State)ent a is incorrect %eca(se -E3 S E-ITOTota" assets. The extent to &hich the ir) (ses de%t inancin$ does not e ect E-IT or tota" assets. State)ent % is incorrect %eca(se ir)s &ith a high *ercenta$e o ixed costs ha'e a hi$h de$ree o o*eratin$ "e'era$e %! de inition. . -E3 S E-ITOTA. Since the! %oth ha'e the sa)e tota" assets and the sa)e -E3A then E-IT )(st %e the sa)e or %oth co)*anies. I A has a hi$her de%t ratio and hi$her interest ex*ense than -A and the! %oth ha'e the sa)e E-IT and tax rateA then A )(st ha'e a "o&er NI than -. There oreA state)ent a is tr(e. I A has a "o&er NI than - %(t %oth ha'e the sa)e tota" assetsA then ACs ROA 8NIOTA9 )(st %e "o&er than -Cs ROA. There oreA state)ent % is tr(e. I %oth co)*anies ha'e the sa)e tota" assets %(t ACs de%t ratio is hi$her than -CsA then ACs e.(it! )(st %e "o&er 8since Tota" assets S Tota" de%t Q Tota" e.(it!9. I A has "ess e.(it!A and a "o&er NI than -A it is not *ossi%"e to +(d$e &hich co)*an!Cs ROE 8NIOEF9 is hi$her. . -E3 S E-ITOTA. I %oth ir)s ha'e the sa)e -E3 ratio and sa)e tota" assetsA then the! )(st ha'e the sa)e E-IT. Since :ir) ; has no de%t in its ca*ita" str(ct(reA :ir) ; &i"" ha'e hi$her net inco)e than :ir) 5 %eca(se ; has no interest ex*ense and 5 does. The TIE ratio is E-ITOInt. I the t&o co)*anies ha'e the sa)e E-ITA the one &ith the "o&er interest ex*ense 8:ir) ;9A &i"" ha'e a hi$her TIE. There oreA state)ent a is a"se. :ir)s 5 and ; ha'e the sa)e E-ITA %(t :ir) 5 has a hi$her interest ex*enseA so its net inco)e &i"" %e "o&er than :ir) ;. Since ROA is e.(a" to NIOTAA and the t&o ir)s ha'e the sa)e tota" assetsA :ir) 5 &i"" ha'e a "o&er ROA than :ir) ;. There oreA state)ent % is tr(e. 5e'era$e &i"" increase ROE i -E3 T ,d. Since -E3 is /< *ercent and ,d is D *ercentA "e'era$e &i"" increase :ir) 5Cs ROE. There oreA state)ent c is a"se. . State)ent a is a"seK ACs net inco)e is "o&er than -Cs d(e to hi$her interest ex*enseA %(t its assets are e.(a" to -CsA so ACs ROA )(st %e "o&er than -Cs ROA. State)ent % is a"seK A has the sa)e E-IT as -A %(t hi$her interest *a!)ents than -K there oreA ACs TIE is "o&er than -Cs. State)ent c is correct. . Ans&er 8-9 is correct. 5e'era$e is the a)o(nt o the ixed cost o ca*ita"A *rinci*a""! de%tA in a ir)Gs ca*ita" str(ct(re re"ati'e to its o*eratin$ inco)e. It is a"so de ined as the ratio o de%t to tota" assets or de%t to ca*ita". 5e'era$eA %! de initionA creates inancia" ris,A &hich re"ates direct"! to the .(estion o the cost o ca*ita". The )ore "e'era$eA the hi$her the inancia" ris,A and the hi$her the cost o de%t ca*ita". The de$ree o inancia" "e'era$e 8D:59 is the *ercenta$e chan$e in earnin$s a'ai"a%"e to co))on stoc,ho"ders that is associated &ith a $i'en *ercenta$e chan$e in net o*eratin$ inco)e 8earnin$s %e ore interest and taxes9. The )ore inancia" "e'era$e e)*"o!edA the $reater the D:5A and the ris,ier the ir). 0hene'er the ret(rn on assets is $reater than the cost o de%tA additiona" "e'era$e is a'ora%"e. An increase in the e.(it! co)*onent o the ca*ita" str(ct(reA ho&e'erA decreases inancia" "e'era$e. O*eratin$ "e'era$e is a re"ated conce*t %ased on the de$ree that ixed costs are (sed in the *rod(ction *rocess. A co)*an! &ith a hi$h *ercenta$e o ixed costs is ris,ier than a ir) in the sa)e ind(str! that re"ies )ore on 'aria%"e costs to *rod(ce. The de$ree o o*eratin$ "e'era$e 8DO59 is the *ercenta$e chan$e in net o*eratin$ inco)e that is associated &ith a $i'en *ercenta$e chan$e in sa"es. 0hen ixed assets increaseA o*eratin$ "e'era$e a"so increases. Ans&er 8A9 is incorrect %eca(se inancia" "e'era$e &o("d decrease and o*eratin$ "e'era$e &o("d increase. Ans&er 8C9 is incorrect %eca(se inancia" "e'era$e &o("d decrease and o*eratin$ "e'era$e &o("d increase. Ans&er 8D9 is incorrect %eca(se inancia" "e'era$e &o("d decrease and o*eratin$ "e'era$e &o("d increase.
135
136
137
17D
139
140
141
. Ans&er 8D9 is correct. Ins(rance is a )ethod o s*readin$ "osses that arise ro) ris,s to &hich )an! *ersons are s(%+ect. 5oss is an (nantici*ated di)in(tion in econo)ic 'a"(e as o**osed to nor)a" de*reciation. Ris, is (ncertaint! a%o(t the occ(rrence or the a)o(nt o "oss. :or exa)*"eA %(i"din$s are s(%+ect to the ris, o "oss %! ire. I the o&ners a"" *a! s)a"" ees 8*re)i()s9 or ins(rance co'era$eA e'er! *artici*ant %ears *art o the "oss instead o a e& %earin$ a"" the "oss. Ans&er 8A9 is incorrect %eca(se ris, a'oidance and "oss contro" do not trans er ris, o "oss. Ans&er 8-9 is incorrect %eca(se an ins(ra%"e interest is )ere"! a *otentia" or econo)ic "oss i an e'ent occ(rs. Ans&er 8C9 is incorrect %eca(se there )(st %e an ins(ra%"e interestA &hich is %asica""! *otentia" or "oss i an e'ent occ(rs. Ga)%"in$ occ(rs &hen on"! a %et is at ris,. . Ans&er 8A9 is correct. An ins(rance contract 8a *o"ic!9 )(st satis ! the (s(a" re.(ire)ents6 o er and acce*tanceA considerationA "e$a"it!A and ca*acit! o the *arties. The ins(red )(st ha'e an ins(ra%"e interest in the s(%+ect )atter o the contract. A"soA the s(%+ect )atter $enera""! )(st exist at the ti)e o contractin$. In the contractA the ins(rer )a,es a *ro)ise to *a! a stated a)o(nt or "oss or in+(r! inc(rred as a res("t o a contin$ent e'ent. Ans&er 8-9 is incorrect %eca(se the *a!ee )a! %e a stran$er to the contract. A *erson &ho ins(res hisOher o&n "i e na)es a third *art! as a %ene iciar!. Moreo'erA not e'er! ins(rer is an ins(rance co)*an!A and the contin$ent e'ent ins(red a$ainst )(st in'o"'e a ris,. Ans&er 8C9 is incorrect %eca(se there is no $enera" re.(ire)ent that an ins(rance contract %e &ritten. Ans&er 8D9 is incorrect %eca(se the contract )a! o ten %e ora"A andA i the ris, is not a"read! in existenceA the transaction is in essence a &a$erA not ins(rance. . Ans&er 8A9 is correct. An ins(rance contract is 'er! si)i"ar to an! other contract. Bo&e'erA an additiona" re.(ire)ent is that the ins(red )(st ha'e an ins(ra%"e interest. Ans&er 8-9 is incorrect %eca(se there is no $enera" re.(ire)ent that an ins(rance contract %e &ritten. Ora" %inders are $i'en e'er! da! in the ins(rance %(siness. Ans&er 8C9 is incorrect %eca(se consideration is needed or the initia" or)ation o an ins(rance contract. The *re)i() )a! %e *aid i))ediate"!A or a *ro)ise to *a! is re.(ired. Ans&er 8D9 is incorrect %eca(se the ins(rance co)*an! can a"so co))it a %reach %! re (sin$ to *a! the *roceeds o the *o"ic! (*on the occ(rrence o the e'ent. . Ans&er 8A9 is correct. 5i e ins(rance is (s(a""! *(rchased to *rotect a$ainst the cessation o inco)e needed or s(**ort o the a)i"! and to shie"d the) ro) the decedentGs de%ts. Ans&er 8-9 is incorrect %eca(se "i e ins(rance is c(sto)ari"! "on$1ter)A i not or "i e. Ans&er 8C9 is incorrect %eca(seA (n"i,e other or)s o ins(ranceA "i e ins(rance does not atte)*t to rei)%(rse or the act(a" a)o(nt o a "oss since "oss o "i e is not )eas(ra%"e. 5i e ins(rance is intended to re*"ace econo)ic %ene its "ost %! a *ersonGs death. Ans&er 8D9 is incorrect %eca(seA exce*t or ter) *o"iciesA "i e ins(rance di ers ro) other ,inds o co'era$e in *ro'idin$ cash 'a"(e. . Ans&er 8D9 is correct. Ter) "i e ins(rance *ro'ides *rotection or a s*eci ied *eriod. 3re)i()s are "e'e" thro($ho(t the *eriod. 0hen the ter) endsA the ins(red recei'es no *a!)ent. Ter) ins(rance )a! %e rene&a%"e 8*ossi%"! at hi$her *re)i()s9 or con'erti%"e to another or). It is the chea*est ,ind o "i e ins(rance. Ans&er 8A9 is incorrect %eca(se &ho"e "i e (rnishes "i eti)e ins(rance *rotection &ith a cash s(rrender 'a"(e. Ans&er 8-9 is incorrect %eca(se an endo&)ent *o"ic! *ro'ides "i e ins(rance *rotection or its d(ration. A cash *a!)ent is )ade 8the *o"ic! endo&s9 at the end o the ter). 3re)i()s or endo&)ent *o"icies are hi$her than or &ho"e "i e ins(rance. Ans&er 8C9 is incorrect %eca(se a strai$ht "i e or ordinar! *o"ic! is &ho"e "i e ins(rance &ith "e'e" *re)i()s *a!a%"e or "i e. . Ans&er 8-9 is correct. 0hen one *erson ins(res the "i e o anotherA the *o"ic!ho"der )(st ha'e an ins(ra%"e interest in the ins(red. That interest is o(nd a)on$ *ersons &ho ha'e a c"ose a)i"! re"ationshi* or ex*ect to s( er s(%stantia" econo)ic "oss ro) the death. -(siness entities are th(s *er)itted to ins(re ,e! *eo*"e in their or$ani#ations &hose death )i$ht ha'e an ad'erse e ect on *ro its. Ans&er 8A9 is incorrect %eca(se a cor*oration has an ins(ra%"e interest on"! in its ,e! e)*"o!eesA i.e.A those &hose death &o("d ca(se "oss to the ir). Ans&er 8C9 is incorrect %eca(se the re.(ired "oss need not %e so $reat as to ca(se cessation o %(siness. Ans&er 8D9 %eca(se one need not %e an o&ner or an o icer to %e ins(ra%"e as a ,e! *erson.
142
143
144
145
146
147
. Ans&er 8A9 is correct. :ire ins(rance is the )ost standardi#ed ,ind o ins(rance. :o""o&in$ the "ead o Ne& Yor,A a")ost a"" states ha'e enacted a standard *o"ic! either %! "e$is"ati'e or ad)inistrati'e action. Ans&er 8-9 is incorrect %eca(seA $i'en that ire ins(rance is (s(a""! &ritten or a 11 to 71!ear *eriodA an incontesta%i"it! c"a(se is not necessar!. S(ch a c"a(se %ars ins(rer de enses a ter a *eriod s*eci ied %! "a& or the *o"ic!. Ans&er 8C9 is incorrect %eca(se a *o"ic! )a! state a de inite 'a"(e o the ins(red *ro*ert! or si)*"! a )axi)() a)o(nt o co'era$e that is not conc"(si'e as to 'a"(ation &hen "oss occ(rs. A *o"ic! )a! th(s %e 'a"(ed or o*en 8(n'a"(ed9. A *ro rata c"a(se is o ten inc"(ded 8%(t not re.(ired9 &hich re.(ires the "oss to %e shared *ro rata &hen there is )ore than one ins(rer. Ans&er 8D9 is incorrect %eca(se the ins(ra%"e interest )ere"! re.(ires the *ersonA e.$.A )ort$a$eeA %ai"eeA etc.A to s( er a "oss i the e'ent ins(red a$ainst occ(rs. . Ans&er 8D9 is correct. I a *re)i() is not recei'ed %! the d(e dateA the *o"ic!ho"der has a $race *eriod (nder state "a&A (s(a""! a )onth or 71 da!sA in &hich to *a!. A ter the $race *eriodA the cash s(rrender 'a"(e is not or eited %(t can %e &ithdra&n or (sed to %(! a *aid1(* *o"ic!. Ans&er 8A9 is incorrect %eca(se "i e ins(rance *o"icies o ten do not co'er death &hi"e the ins(red is in the )i"itar!. Ans&er 8-9 is incorrect %eca(se "i e ins(rance *o"icies o ten do not co'er death as a res("t o a nonco))ercia" air "i$ht. Ans&er 8C9 is incorrect %eca(se a "a*sed *o"ic! )a! o ten %e reinstated %! *a!)ent o o'erd(e *re)i()s *"(s interest. . Ans&er 8-9 is correct. Ordinari"!A s)o,eA &aterA or other da)a$e ca(sed %! hosti"eA %(t not riend"!A ires &i"" %e inde)ni ied (nder a ire ins(rance *o"ic!. Bosti"e ires are those i$nited in *"aces &here the! are not )eant to %e. A riend"! ire is one that %(rns &here it is intended to %(rnA s(ch as a ire*"ace or (rnace. :or exa)*"eA i a riend"! ire is ,e*t &ithin its (s(a" containerA da)a$e ca(sed %! s)o,e ro) it &i"" not %e rei)%(rsed. Ans&er 8A9 is incorrect %eca(se ire ins(rance (s(a""! inde)ni ies or "oss ca(sed %! hosti"eA %(t not riend"!A ires. Ans&er 8C9 is incorrect %eca(se ire ins(rance (s(a""! inde)ni ies or "oss ca(sed %! hosti"eA %(t not riend"!A ires. Ans&er 8D9 is incorrect %eca(se ire ins(rance (s(a""! inde)ni ies or "oss ca(sed %! hosti"eA %(t not riend"!A ires. . Ans&er 8C9 is correct. ArsonA ra(dA or another intentiona" act o the ins(red ca"c("ated to ca(se the da)a$e ins(red a$ainst &i"" *rec"(de reco'er!. The *arties to an ins(rance contract ha'e an i)*"ied d(t! not to %rin$ a%o(t the 'er! e'ent that is the s(%+ect )atter o the *o"ic!. Ans&er 8A9 is incorrect %eca(se a$enc! r("es do not a**"!K i.e.A the intentiona" act o an a$ent &i"" not %e i)*(ted to the ins(red (nder the doctrine o res*ondeat s(*erior. Arson %! an a$ent &itho(t the act(a" ,no&"ed$e or cons*irac! o the ins(red &i"" not *rec"(de reco'er!. Ans&er 8-9 is incorrect %eca(se arson is co)*ensa%"e (n"ess intended %! the ins(red. Ans&er 8D9 is incorrect %eca(se ne$"i$ence &itho(t ra(d &i"" not *re'ent reco'er! %! an ins(red &ho has acted in $ood aith. . Ans&er 8D9 is correct. :ire ins(rance $enera""! *rotects the ins(red ro) da)a$e to the ins(red *ro*ert! as a res("t o ire. It does not co'er the ins(red or ca(sin$ a ire on so)eone e"seGs *ro*ert!. Ans&er 8A9 is incorrect %eca(se )a"*ractice ins(rance is a s*ecia" or) o "ia%i"it! ins(rance *rotectin$ *ro essiona"s ro) "a&s(its %! third *arties or ne$"i$ence. Ans&er 8-9 is incorrect %eca(se ho)eo&ners ins(rance $enera""! contains a "ia%i"it! section in the e'ent $(ests are in+(red on the *re)ises. Ans&er 8C9 is incorrect %eca(se a *ri)ar! *(r*ose o a(to)o%i"e ins(rance is to *rotect the o&ner or dri'er ro) "ia%i"it! in the e'ent 8s9he is res*onsi%"e or da)a$e to another *erson or *ro*ert!. . Ans&er 8C9 is correct. Co1ins(rance is a )ethod o sharin$ ris, %et&een the ins(rer and the ins(red. A co1ins(rance c"a(se t!*ica""! *ro'ides thatA i the *o"ic!ho"der ins(res hisOher *ro*ert! or at "east a stated *ercenta$e 8(s(a""! D<J9 o its act(a" cash 'a"(eA an! "oss &i"" %e *aid in ("" (* to the ace a)o(nt o the *o"ic!. Th(sA a co1ins(rance c"a(se is (sed %! )an! *ro*ert! and cas(a"t! ins(rers to enco(ra$e *o"ic!ho"ders to ins(re co))ercia" *ro*ert! or an a)o(nt that is near to its ("" re*"ace)ent cost. Ans&er 8A9 is incorrect %eca(seA i a *o"ic!ho"der does not ins(re the *ro*ert! or an a)o(nt c"ose eno($h to its ("" re*"ace)ent costA the *o"ic!ho"der )(st %ear a *ro*ortionate *art o an! *artia" "oss. Ans&er 8-9 is incorrect %eca(se the co1ins(rance re.(ire)ent a**"ies on"! to *artia" "osses. Tota" "osses res("t in reco'er! o the ace a)o(nt o the *o"ic!. Ans&er 8D9 is incorrect %eca(se a co1ins(rance c"a(se enco(ra$es *o"ic!ho"ders to ins(re co))ercia" *ro*ert! or an a)o(nt that is near to its ("" re*"ace)ent cost.
148
149
150
151
152
153
. Ans&er 8A9 is correct. Conditions *recedentA ca""ed &arrantiesA are *art o the *ro*ert! ins(rance *o"ic!. -reach o a &arrant! *rec"(des reco'er! and res("ts in a or eit(re. Since the "a& dis a'ors or eit(resA co(rts constr(e .(estions o inter*retation a'ora%"! to the ins(red and a$ainst the ins(rer that dra ted the *o"ic!. Bo&e'erA i the *arties ex*ress"! a$ree that certain state)ents are &arrantiesA then a co(rt &o("d reco$ni#e the) as &arranties. Since [e&e"r! &arranted ne'er to dis*"a! )ore than W1<A<<< o +e&e"r!A the %reach o &arrant! *re'ents reco'er!. Ans&er 8-9 is incorrect %eca(se [e&e"r! &i"" reco'er nothin$K it is not entit"ed to W/A<<<. Ans&er 8C9 is incorrect %eca(se the &arrant! &i"" not %e constr(ed as a )ere re*resentationK the intention o the *arties c"ear"! &as to )a,e it a &arrant!. Ans&er 8D9 is incorrect %eca(se attach)ent o the a**"ication to the *o"ic! is (s(a""! s( icient to )a,e it a *art thereo . It )a! a"so %e incor*orated into the *o"ic! %! re erence to it.

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MANAGEMENT ADVISORY SERVICES INVESTMENT RISK 1 . Catherine & Co. has extra cash at the end o the !

C. 3ort o"io ris,. D. Mar,et ris,. C. Increasin$ ex*ected ret(rn.

C. :ir) s*eci ic ris, D. A"" o the a%o'e

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

RISKS D. Bi$h standard de'iation o ret(rns. G"ei) %. c. d. e.

C. De)and 'aria%i"it!. D. :"(ct(ations in s(**"iersG *rices.

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

MANAGEMENT ADVISORY SERVICES

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

MANAGEMENT ADVISORY SERVICES

CIA <@>/ IV14>

C. Q1.< D. R1.< C. Q1.< D. R1.< C. R1.< D. Q1.<

CIA <@D@ IV1/D

C. Tota" ris, D. None o the a%o'e

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

C. %A T %E T %D D. None o the a%o'e are tr(e

C. %A U %E U %D D. None o the a%o'e are tr(e

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

RISKS A. Q1 -. < C. R<.@ D. R1 -&M

MANAGEMENT ADVISORY SERVICES A. 0or,in$ ca*ita" )ana$e)ent. -. Ret(rn )axi)i#ation.

C. Ana"!sis o 3ricin$ Techni.(e D. Ana"!sis 3ricin$ Theor!

RISKS -ar ie"d a. %. c. d.

MANAGEMENT ADVISORY SERVICES

CMA <=>@ 11=

. 0hich o the o""o&in$ state)ents is )ost correct2 8E9

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

MANAGEMENT ADVISORY SERVICES a. %. c. d.

C. C(rrent Ar%itra$e 3ricin$ Method - & M D. C()("ati'e Ar%itra$e 3ricin$ Mode"

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

C. rE T rA T rD D. None o the a%o'e are tr(e

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

MANAGEMENT ADVISORY SERVICES

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

CIA <@>? IV1@<

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

RISKS D. Ter). G"ei)

MANAGEMENT ADVISORY SERVICES

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

MANAGEMENT ADVISORY SERVICES

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

R3C3AA AIC3A. CMA & CIA EEAMINATION F;ESTIONS

Corporate risk Corporate risk

Answer: b Diff: E Answer: e Diff: M

# "$k k # "p C%&$'(" = $k !i k ! i i

# "$k k # "p C%&$'(" = $k !i k ! i i

interest1rate s&a*s and c(rrenc! s&a*s.

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T04 - Risks & Cost of Capital

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