Practice questions from chapters 10-12 (with a few bonus questions from chapter 13).

1. The excess return required on a risky asset over that earned on a risk-free asset is called (a):
A) Risk premium.
) Return premium.
!) "xcess return.
#) Avera$e return.
") %ariance.
Ans&er: A
'. An efficient capital market is one in &hich:
A) rokera$e commissions are (ero.
) Taxes are irrelevant.
!) )ecurities al&ays offer a positive rate of return to investors.
#) )ecurity prices are $uaranteed (*y the )ecurities and "xchan$e !ommission) to *e fair.
") )ecurity prices reflect availa*le information.
Ans&er: "
+. The hypothesis that market prices reflect all availa*le, pu*lic and private, information is called
efficiency in the:
A) -pen form.
) )tron$ form.
!) )emi-stron$ form.
#) .eak form.
") )ta*le form.
Ans&er:
/. The hypothesis that market prices reflect all pu*licly-availa*le information is called efficiency in
the:
A) -pen form.
) )tron$ form.
!) )emi-stron$ form.
#) .eak form.
") )ta*le form.
Ans&er: !
0. The hypothesis that market prices reflect all historical information is called efficiency in the:
A) -pen form.
) )tron$ form.
!) )emi-stron$ form.
#) .eak form.
") )ta*le form.
Ans&er: #
1. -ver the past 21 years, &hich of the follo&in$ investments has provided the lar$est avera$e
return3
A) )mall company stocks
) !ommon stocks
!) Treasury *ills
#) Treasury *onds
") !orporate *onds
Ans&er: A
2. -ver the past 21 years, &hich of the follo&in$ investments has *een the least risky3
A) )mall company stocks
) !ommon stocks
!) Treasury *ills
#) Treasury *onds
") !orporate *onds
Ans&er: !
4. 5ou track the liquidity of companies and find that you can consistently earn unusually hi$h
returns *y purchasin$ the shares of firms &hose stock price falls *elo& the cash value per share
as indicated on the *alance sheet. .hich of the follo&in$ descri*es this strate$y3
A) This &ould not *e a violation of market efficiency.
) This &ould *e a violation of &eak form efficiency.
!) This &ould *e a violation of semi-stron$ form efficiency.
#) This &ould *e a violation of stron$ form efficiency.
") This &ould *e a violation of all forms of market efficiency.
Ans&er: !
6. 7ast year you purchased 1,888 shares of )un 9icrosystems stock for :10 per share. Accordin$ to
today;s quote in The Wall Street Journal, the stock is currently sellin$ for :+ per share. The stock
pays no dividends. 5our return on this investment is comprised of <<<<<<<<<<<<<.
A) retained earnin$s and dividend yields
) an income return and a capital $ains return
!) a real return only
#) a capital $ains return only
") there is no return, since you lost money on this investment
Ans&er: #
18. .hich of the follo&in$ is $enerally considered to represent the risk-free return3
A) !ommon stocks
) )mall stocks
!) 7on$-term $overnment *onds
#) 7on$-term corporate *onds
") Treasury *ills
Ans&er: "
11. 5ou purchased a *ond for :428 one year a$o. Today, you receive your only interest payment for
the year of :28. The *ond can currently *e sold for :6'0. .hat is your total percenta$e return on
investment3 =$nore tax effects.
A) 1.+>
) 4.1>
!) 1/./>
#) 11.0>
") '8.4>
Ans&er: !
1'. 5ou purchased 088 shares of preferred stock on ?anuary 1, '88', for :40 per share. The stock
pays an annual dividend of :1' per share. -n #ecem*er +1, '88', the market price is :61 per
share. .hat is your total dollar return for the year3
A) : +,888
) : /,088
!) : 1,888
#) : 6,888
") :1',888
Ans&er: #
Response: 088 (:61 - 40 @ 1') A :6,888
1+. 5ou purchased a *ond on ?anuary 1, '88', for :1,810. The *ond has a :1,888 face value, a 18>
annual coupon, and can *e sold for :620 on #ecem*er +1, '88'. .hat is your percenta$e return
on investment for the year3
A) B/.1>
) 8.6>
!) /.1>
#) 4.+>
") 1'.0>
Ans&er:
Response: R A C(:620 - 1,810) D 1,810E @ (188 D 1,810) A .886/
1/. 5ou purchased 088 shares of preferred stock on ?anuary 1, '88', for :08 per share. The stock
pays an annual dividend of :4 per share. -n #ecem*er +1, '88', the market price is :0/ per
share. .hat is your percenta$e return on investment for the year3
A) />
) 4>
!) 11>
#) '8>
") '/>
Ans&er: "
Response: R A C(:0/ - 08) D 08E @ (4 D 08) A .'/
Fse the follo&in$ to ans&er questions 10-14:
5ou purchase 488 shares of stock at a price of :'8 per share. -ne year later, the shares are sellin$ for :'+
per share. =n addition, a dividend of :' per share is paid at the end of each year.
10. .hat is the total dollar return for the investment3
A) :1,188
) :',/88
!) :/,888
#) :1,488
") :4,888
Ans&er: !
Response: 488 (:'+ - '8 @ ') A :/,888
11. .hat is the capital $ains yield for the investment3
A) 4.0>
) 18.8>
!) 11.0>
#) 1+.8>
") 10.8>
Ans&er: "
Response: !G5 A (:'+ - '8) D '8 A .10
12. .hat is the dividend yield for the investment3
A) '.0>
) 2.0>
!) 18.8>
#) 10.8>
Ans&er: !
Response: #5 A :' D '8 A .18
14. .hat is the total percenta$e return for the investment3
A) 0>
) 18>
!) 10>
#) '8>
") '0>
Ans&er: "
Response: R A C(:'+ - '8) D '8E @ (' D '8) A .'0
Chapter 11 questions begin here
1. A portfolio is <<<<<<<<<<<<<<<<<<<<<<<<<<<.
A) a $roup of assets, such as stocks and *onds, held as a collective unit *y an investor
) the expected return on a risky asset
!) the expected return on a collection of risky assets
#) the variance of returns for a risky asset
") the standard deviation of returns for a collection of risky assets
Ans&er: A
'. The percenta$e of a portfolio;s total value invested in a particular asset is called that asset;s:
A) Hortfolio return.
) Hortfolio &ei$ht.
!) Hortfolio risk.
#) Rate of return.
") =nvestment value.
Ans&er:
+. Risk that affects a lar$e num*er of assets, each to a $reater or lesser de$ree, is called:
A) =diosyncratic risk.
) #iversifia*le risk.
!) )ystematic risk.
#) Asset-specific risk.
") Total risk.
Ans&er: !
/. Risk that affects at most a small num*er of assets is called:
A) Hortfolio risk.
) Fndiversifia*le risk.
!) 9arket risk.
#) Fnsystematic risk.
") Total risk.
Ans&er: #
0. The principle of diversification tells us that:
A) !oncentratin$ an investment in t&o or three lar$e stocks &ill eliminate all of your risk.
) !oncentratin$ an investment in t&o or three lar$e stocks &ill reduce your overall risk.
!) )preadin$ an investment across many diverse assets cannot (in an efficient market) eliminate
any risk.
#) )preadin$ an investment across many diverse assets &ill eliminate all of the risk.
") )preadin$ an investment across many diverse assets &ill eliminate some of the risk.
Ans&er: "
1. The <<<<<<<<<<<<<<<<<<< tells us that the expected return on a risky asset depends only on that
asset;s systematic risk.
A) "fficient 9arkets Iypothesis ("9I)
) systematic risk principle
!) -pen 9arkets Theorem
#) 7a& of -ne Hrice
") principle of diversification
Ans&er:
2. The amount of systematic risk present in a particular risky asset, relative to the systematic risk
present in an avera$e risky asset, is called the particular asset;s:
A) eta coefficient.
) Re&ard to risk ratio.
!) 7a& of -ne Hrice.
#) #iversifia*le risk.
") Treynor index.
Ans&er: A
4. The linear relation *et&een an asset;s expected return and its *eta coefficient is the:
A) Re&ard to risk ratio.
) Hortfolio &ei$ht.
!) Hortfolio risk.
#) )ecurity market line.
") 9arket risk premium.
Ans&er: #
6. #iversification &orks *ecause:
A) Fnsystematic risk exists.
) Jormin$ stocks into portfolios reduces the standard deviation of returns for each stock.
!) Jirm-specific risk can *e never *e reduced.
#) )tocks earn hi$her returns than *onds.
") Hortfolios have hi$her returns than individual assets.
Ans&er: A
18. A security has an unexpected ne$ative ne&s announcement specific to that security. 9ost likely,
the <<<<<<<<<<<<<<<<<<<<<<<<<<<<<<.
A) security;s required return on investment &ill increase.
) security;s required return on investment &ill remain unchan$ed.
!) security;s required return on investment &ill decrease.
#) market risk premium &ill increase.
") security;s market price &ill remain unchan$ed.
Ans&er: A
11. Ke& information re$ardin$ a security, &hen received *y the market, leads to a(n):
A) Fnexpected return.
) "xpected return.
!) Actual return.
#) )ystematic return.
") Kon-diversifia*le return.
Ans&er: A
1'. 5ou o&n 08 shares of stock A, &hich has a price of :1' per share, and 188 shares of stock ,
&hich has a price of :+ per share. .hat is the portfolio &ei$ht for stock A in your portfolio3
A) '0>
) ++>
!) 08>
#) 12>
") 20>
Ans&er: #
Response: 08(:1') @ 188(+) A :688L &
A
A :188 D 688 A .12
1+. .hat is the expected return for the follo&in$ stock3
) t a t e H r o * a * i l i t y R e t u r n
A v e r a $ e . 0 8 . ' 0
R e c e s s i o n . + 0 . 8 0
# e p r e s s i o n . 1 0 B . + 0
A) .80
) .84
!) .86
#) .18
") .1'
Ans&er: !
Response: 08(.'0) @ .+0(.80) @ .10(-.+0) A .86
1/. .hat is the risk premium for the follo&in$ returns if the risk-free rate is />3
) t a t e H r o * a * i l i t y R e t u r n
o o m . ' 8 . 2 0
G o o d . 0 0 . ' 0
R e c e s s i o n . 1 0 B . 1 8
# e p r e s s i o n . 1 8 B . 0 8
A) 8.++'0
) 8.10'0
!) 8.80'0
#) 8.14'0
") 8.'''0
Ans&er: #
Response: .'8(.20) @ .00(.'0) @ .10(-18)@ .18(-08) A .'''0L RH A .'''0 .8/ A .14'0
10. .hat is the expected portfolio return $iven the follo&in$ information:
A s s e t H o r t f o l i o & e i $ h t R e t u r n
A . + 0 ' 8 >
. 1 0 + 0 >
! . ' 0 1 >
# . ' 0 1 ' >
A) 1.20>
) 6.08>
!) 11.20>
#) 14.'0>
") '1.08>
Ans&er: !
Response: .+0(.'8) @ .10(.+0) @ .'0(.81) @ .'0(.1') A .1120
11. .hat is the expected return on asset A if it has a *eta of 8.1, the expected market return is 10>,
and the risk-free rate is 1>3
A) 0./>
) 6.1>
!) 11./>
#) 10.8>
Ans&er: !
Response: 1 @ .1(10 - 1) A 11./>
Chapter 12 questions begin here
1. The opportunity cost associated &ith the firm;s capital investment in a proMect is called its:
A) !ost of capital.
) eta coefficient.
!) !apital $ains yield.
#) )unk cost.
") =nternal rate of return.
Ans&er: A
'. The return that shareholders require on their investment in the firm is called the:
A) #ividend yield.
) !ost of equity.
!) !apital $ains yield.
#) !ost of capital.
") =ncome return.
Ans&er:
+. The return that lenders require on their loaned funds to the firm is called the:
A) !oupon rate.
) !urrent yield.
!) !ost of de*t.
#) !apital $ains yield.
") !ost of capital.
Ans&er: !
/. The &ei$hted avera$e of the firm;s costs of equity, preferred stock, and aftertax de*t is the:
A) Re&ard to risk ratio for the firm.
) "xpected capital $ains yield for the stock.
!) "xpected capital $ains yield for the firm.
#) Hortfolio *eta for the firm.
") .ei$hted avera$e cost of capital (.A!!).
Ans&er: "
0. All of the follo&in$ could *e considered advanta$es in assessin$ the cost of preferred stock
compared to the cost of common stock "N!"HT:
A) Hreferred stock $enerally carries &ith it a fixed dividend payment.
) Hreferred stock is often rated for default risk.
!) The cost of preferred stock is simply equal to its dividend yield.
#) The cost of preferred stock can *e calculated as a perpetuity *ased on the fixed dividend
payment and the present stock price.
") Fnlike common stock, preferred stock requires no assumptions *e made a*out future cash
flo&s.
Ans&er: "
1. .hich of the follo&in$, amon$ other thin$s, is needed to calculate the &ei$hted avera$e cost of
capital for a non-profit corporation3
A) The par value of *onds outstandin$.
) The *ond ratin$ of the firm;s outstandin$ de*t issues.
!) The corporate tax rate.
#) The num*er of preferred shares outstandin$.
") The operatin$ cash flo& for the most recent reportin$ period.
Ans&er: #
2. All else the same, a hi$her corporate tax rate <<<<<<<<<<<<<<<<<<<<<.
A) &ill decrease the .A!! of a firm &ith some de*t in its capital structure
) &ill increase the .A!! of a firm &ith some de*t in its capital structure
!) &ill not affect the .A!! of a firm &ith some de*t in its capital structure
#) &ill decrease the .A!! of a firm &ith no de*t in its capital structure
") &ill chan$e the .A!! of a firm &ith some de*t in its capital structure, *ut the direction is
unclear.
Ans&er: A
4. To estimate the cost of equity for a firm, &hich of the follo&in$ varia*les &ould K-T *e needed3
A) The current dividend payment.
) The risk-free interest rate.
!) The de*tDequity ratio.
#) The *eta coefficient.
") The market price of the stock.
Ans&er: !
6. A firm is expected to pay a dividend of :+.08 per share in one year. This dividend, alon$ &ith the
firm;s earnin$s, is expected to $ro& at a rate of 2> forever. =f the current market price for a share
is :12, &hat is the cost of equity3
A) 2.88>
) 1'.''>
!) 10.1/>
#) 1/.88>
") 1+./1>
Ans&er:
Response: (:+.08 D 12) @ .82 A .1'''
18. The lon$-term de*t of your firm is currently sellin$ for 186> of its face value. The issue matures
in 1' years and pays an annual coupon of 2.0>. .hat is the cost of de*t3
A) 0.18>
) 1./8>
!) 2.08>
#) 4.68>
") 6.+8>
Ans&er:
Response: :1,868 A :20OC1 - 1D(1 @ 5T9)
1'
E D 5T9P @ 1,888 D (1 @ 5T9)
1'L
5T9 A 1./8>
11. A company;s preferred stock pays an annual dividend of :2.88 per share. .hen issued, the shares
sold for their par value of :188 per share. .hat is the cost of preferred stock if the current price is
:1'8 per share3
A) 0.4>
) 2.8>
!) 4.1>
#) 6.1>
") 1'.8>
Ans&er: A
Response: :2 D 1'8 A .804
1'. )uppose that your firm has a cost of equity of 14> and a cost of de*t of 4>. =f the tar$et
de*tDequity ratio is 8.18, and the tax rate is +0>, &hat is the firm;s &ei$hted avera$e cost of
capital (.A!!)3
A) 2./>
) 6.6>
!) 11.4>
#) 1+.'>
") 1/.+>
Ans&er: #
Response: .14(18D11) @ .84(1D11)(1-+0) A .1+'
1+. )uppose a firm has 16 million shares of common stock outstandin$ &ith a par value of :1.88 per
share. The current market price per share is :14.+0. The firm has outstandin$ de*t &ith a par
value of :11/.0 million sellin$ at 61> of par. .hat capital structure &ei$ht &ould you use for
de*t &hen calculatin$ the firm;s .A!!3
A) 8.10
) 8.'/
!) 8.0/
#) 8.21
") 8.61
Ans&er:
Response: % A 169(:14.+0) @ 11/,088(:618) A :/04,028,888L #D% A :186.6'9 D /04.029 A .
'/8
1/. A common stock issue is currently sellin$ for :+1 per share. 5ou expect the next dividend to *e
:1./8 per share. =f the firm has a dividend $ro&th rate of 0> that is expected to remain constant
indefinitely, &hat is the firm;s cost of equity3
A) 6.0>
) 11.+>
!) 1+.4>
#) 1/.'>
") 10.1>
Ans&er: A
Response: (:1./8D+1) @ .80 A .860'
10. Given the follo&in$ information, &hat is the avera$e annual dividend $ro&th rate3
# i v i d e n d : 1 . 4 8 : 1 . 6 8 : ' . 1 0 : ' . ' 4 : ' . / 6 : ' . 2 0
A) /.6>
) 1.'>
!) 4.4>
#) 6.2>
") 18.+>
Ans&er: !
Response: (:.18D1.48 @ .'0D1.68 @ .1+D'.10 @ .'1D'.'4 @ .'1D'./6) D 0 A .8444
11. Treasury *ills currently have a return of '.0> and the market risk premium is 2>. =f a firm has a
*eta of 1./, &hat is its cost of equity3
A) 4.1>
) 6.6>
!) 18.4>
#) 1'.+>
") 1/./>
Ans&er: #
Response: '.0 @ 1./(2) A 1'.+>
12. 5our firm sold a '0-year *ond at par 16 years a$o. The *ond pays an 1> annual coupon, has a
:1,888 face value, and currently sells for :4'0. .hat is the firm;s cost of de*t3
A) 1.8>
) 4.'>
!) 6.0>
#) 18.8>
") 11.+>
Ans&er: #
Response: :4'0 A :18OC1 - 1D(1 @ 5T9)
1
E D 5T9P @ 1,888 D (1 @ 5T9)
1
L 5T9 A 18.8'>
14. A company has preferred stock outstandin$ &hich pays a dividend of :1 per share a year. The
current stock price is :20 per share. .hat is the cost of preferred stock3
A) 1>
) 2>
!) 18>
#) 6>
") 4>
Ans&er: "
Response: :1 D 20 A .84
16. A firm sold a 18-year *ond issue + years a$o. The *ond has a 1./0> annual coupon and a :1,888
face value. =f the current market price of the *ond is :601.1/ and the tax rate is +0>, &hat is the
aftertax cost of de*t3
A) +.08>
) 0.66>
!) 1./0>
#) 2.+1>
") /.24>
Ans&er: "
Response:
:601.1/ A :1/.08OC1 - 1D(1 @ 5T9)
2
E D 5T9P @ 1,888 D (1 @ 5T9)
2
L 5T9 A 2.+06>
AT A 2.+06(1-.+0) A /.24+>
'8. Given the follo&in$ information, &hat is the firm;s &ei$hted avera$e cost of capital3 9arket
value of equity A :+8 millionL market value of de*t A :'8 millionL cost of equity A 10>L cost of
de*t A 6>L equity *eta A 1./L tax rate A +0>.
A) 11.+/>
) 1'.18>
!) 1'.62>
#) 1+.+'>
") 1/.84>
Ans&er: A
Response: 10(:+89D089) @ 6('89D089)(1-.+0) A 11.+/>
Chapter 13 questions begin here
1. The equity risk derived from the firm;s operatin$ activities is called <<<<<<<<<<< risk.
A) market
) systematic
!) extrinsic
#) *usiness
") financial
Ans&er: #
'. The equity risk derived from the firm;s capital structure policy is called <<<<<<<<<<< risk.
A) market
) systematic
!) extrinsic
#) *usiness
") financial
Ans&er: "
+. The tax savin$s of the firm derived from the deducti*ility of interest expense is called the:
A) =nterest tax shield.
) #eprecia*le *asis.
!) Jinancin$ um*rella.
#) !urrent yield.
") Tax-loss carryfor&ard savin$s.
Ans&er: A
/. The financial levera$e of a firm &ill <<<<<<<<<<<<<<<<<<<<<< .
=. decrease as the de*tDequity ratio increases
==. decrease as the firm;s retained earnin$s account $ro&s
===. decrease if the firm has ne$ative net income
A) = only
) == only
!) === only
#) = and == only
") == and === only
Ans&er:
0. The optimal capital structure is the mixture of de*t and equity &hich:
=. 9aximi(es the value of the firm.
==. 9aximi(es the firm;s &ei$hted avera$e cost of capital.
===. 9aximi(es the market price of the firm;s *onds.
A) = only
) === only
!) = and == only
#) = and === only
") =, == and ===
Ans&er: A
1. A*ove the *reakeven "=T, increased financial levera$e &ill <<<<<<<<<< "H), all else the same.
Assume there are no taxes.
A) increase
) decrease
!) not affect
#) either increase or decrease
") increase "=T *ut decrease
Ans&er: A
2. <<<<<<<<<<< arises from decisions that affect the left-hand side of the *alance sheet,
&hile<<<<<<<<<<< arises from decisions that affect the ri$ht-hand side of the *alance sheet.
A) )ystematic riskL financial risk
) )ystematic riskL unsystematic risk
!) Fnsystematic riskL systematic risk
#) usiness riskL financial risk
") usiness riskL diversifia*le risk
Ans&er: #
4. .hich of the follo&in$ statements is true3
A) The financial risk of a firm decreases &hen it takes on a risky proMect.
) The financial risk of a firm increases &hen it takes on more equity.
!) The *usiness risk of a firm increases &hen it takes on a risky proMect.
#) The *usiness risk of a firm increases &hen it takes on more de*t.
") The hi$her the *usiness risk for a firm, the hi$her the financial risk as &ell.
Ans&er: !