- Description
FIN 571 Wk 5 – Practice: Wk 5 Practice Questions
Periods of market decline are called:
Multiple Choice
- discount factors.
- bull markets.
- coupons.
- bear markets.
Over the past 4 years an investment returned 18%, −9%, −12%, and 15%. What is the standard deviation of returns?
Multiple Choice
- 9.2%
- 10.36%
- 11.2%
- 13.6%
The variance of an investment’s returns is a measure of the:
Multiple Choice
- volatility of the rates of return.
- probability of a negative return.
- historic return over long time periods.
- average value of the investment.
Risks that are peculiar to a single firm:
Multiple Choice
- are called market risks
- cannot be diversified away
- are called specific risks
- tend to cause stocks to move together
Which one of the following risks is most important to a well-diversified investor in common stocks?
Multiple Choice
- Market risk
- Specific risk
- Unsystematic risk
- Diversifiable risk
Suppose that the Treasury bill rate is 9% rather than 5%, as we assumed in Table 12.1, and the expected return on the market is 10%. Use the betas in that table to answer the following questions.
- When you assume this higher risk-free interest rate, what makes sense for how you should modify your assumption about the rate of return on the market portfolio? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
- Recalculate the expected return on the stocks in Table 12.1. (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
- Suppose now that you continued to assume that the expected return on the market remained at 10%. Now what would be the expected returns on each stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
- Ford offer a higher or lower expected return if the interest rate is 9% rather than 5%?
- Walmart offer a higher or lower expected return if the interest rate is 9% rather than 5%?
If the expected rate of return on the market portfolio is 12% and T-bills yield 4%, what must be the beta of a stock that investors expect to return 9%? (Round your answer to 4 decimal places.)
A stock with a beta of 2.1 has an expected rate of return of 32%. If the market return this year turns out to be 13 percentage points below expectations, what is your best guess as to the rate of return on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
The Treasury bill rate is 4% and the market risk premium is 7%.
Project Beta Internal Rate of Return, %
P 0.85 18
Q 0.00 14
R 2.00 18
S 0.25 15
T 1.50 20
________________________________________
- What are the project costs of capital for new ventures with betas of 0.60 and 1.57? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)
- Which of the capital investments shown above have positive (non-zero) NPV’s? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a answer and double click the box with the question mark to empty the box for a wrong answer.)
check all that apply
- Project P
- Project Q
- Project S
- Project T
- Project RIn
You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows:
Years Cash Flow
0 – 100
1-10 + 15
________________________________________
On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.34. Assuming that the rate of return available on risk-free investments is 5% and that the expected rate of return on the market portfolio is 14%, what is the net present value of the project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions of dollars rounded to 2 decimal places.)
Which one of the following statements is in concerning stock indexes?
Multiple Choice
Indexes have been developed for foreign stocks.
Some indexes cover only a specific market sector.
Most indexes include all of the publicly-traded common stocks.
Some indexes are equally weighted.
“Dow up 14. Story at 6:00.” This means that:
Multiple Choice
the Dow was up 14% during today’s trading.
14 of the Dow’s 30 stocks increased in price today.
a share of Dow stock went up by $14 today.
the Dow index increased by 14 points in today’s trading.
Periods of market decline are called:
Multiple Choice
discount factors.
bull markets.
coupons.
bear markets.
When the annual rate of return on U.S. Treasury bills is historically high, investors expect the return on the stock market:
Multiple Choice
considerably lower than normal.
about average.
also to be high.
approximately equal to zero.
Sue purchased a stock for $25 a share, held it for one year, received a $1.34 dividend, and sold the stock for $26.45. What nominal rate of return did she earn?
Multiple Choice
11.16%
14.23%
12.09%
10.55%
If the toss of a coin comes down heads, you win a dollar. If it comes down tails, you lose fifty cents. How much would you expect to gain after 20 tosses?
Multiple Choice
$5.00
$7.50
$10.00
$15.00
In a year in which common stocks offered an average return of 12% and Treasury bills offered 3%. The risk premium for common stocks was:
Multiple Choice
1%.
3%.
12%.
9%.
A good way to reduce macro risk in a stock portfolio is to invest in stocks that:
Multiple Choice
have only specific risks.
have diversified away the macro risk.
have low exposure to business cycles.
pay guaranteed dividends.
A stock investor owns a diversified portfolio of 15 stocks. What will be the most likely effect on the portfolio’s standard deviation if one more stock is added?
Multiple Choice
A slight increase will occur.
A large increase will occur.
A slight decrease will occur.
A large decrease will occur.
The incremental risk to a portfolio from adding another stock:
Multiple Choice
is always greater than the average portfolio risk.
is always less than the average portfolio risk.
is always positive.
may be either positive or negative.
Individual stocks are:
Multiple Choice
exposed to the same amount of market risk.
exposed to differing amounts of market risk.
not exposed to market risk; only the general economy is subject to market risk.
exposed to differing amounts of market risk but the same amount of specific risk.
Which one of the following firms is likely to exhibit the least macro risk exposure?
Multiple Choice
Construction company
Airline company
Gold mining company
Auto manufacturer
Which statement is concerning macro risk exposure?
Multiple Choice
All firms face equal macro risk exposure.
Only portfolios of stocks face macro risk exposure.
Macro risk exposure affects the cost of capital.
Macro risk exposure is less important to diversified investors than micro risk exposure.
A share of stock with a beta of 0.76 now sells for $51. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 3%, and the market risk premium is 7%.
- Suppose investors believe the stock will sell for $53 at year-end. Calculate the opportunity cost of capital. Is the stock a good or bad buy? What will investors do? (Do not round intermediate calculations. Round your opportunity cost of capital calculation as a percentage rounded to 2 decimal places.)
- At what price will the stock reach an “equilibrium” at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Stock A has a beta of 0.5, and investors expect it to return 10%. Stock B has a beta of 1.5, and investors expect it to return 16%. Use the CAPM to calculate the market risk premium and the expected rate of return on the market. (Enter your answers as a whole percent.)
The risk-free rate is 5% and the expected rate of return on the market portfolio is 10%.
- Calculate the required rate of return on a security with a beta of 1.23. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
- If the security is expected to return 12%, is it overpriced or underpriced?
Underpriced
Overpriced
A stock with a beta of 1.9 has an expected rate of return of 28%. If the market return this year turns out to be 12 percentage points below expectations, what is your best guess as to the rate of return on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
Problem 12-12 CAPM and Cost of Capital (LO3)
The Treasury bill rate is 5% and the market risk premium is 8%.
Project Beta Internal Rate of Return, %
P 0.70 12
Q 0 8
R 1.00 14
S 0.10 9
T 1.10 13
________________________________________
- What are the project costs of capital for new ventures with betas of .45 and 1.45? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Beta Cost of Capital
0.45 8.60 %
1.45 16.60 %
________________________________________
- Which of the following capital investments have positive NPVs? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a answer and double click the box with the question mark to empty the box for a wrong answer.)
A project under consideration has an internal rate of return of 14% and a beta of .6. The risk-free rate is 4%, and the expected rate of return on the market portfolio is 14%.
You are considering the purchase of real estate that will provide perpetual income that should average $50,000 per year. How much will you pay for the property if you believe its market risk is the same as the market portfolio’s? The T-bill rate is 5%, and the expected market return is 12.5%.
Suppose that the S&P 500 with a beta of 1.0 has an
expected return of 13% and T Bills provide a risk free return
of 4%.
(a) what would be the expected return and beta of the
portfolios constructed from these two assets with weights
in the S&P500 of (i) 0; (ii) .25; (iii) .50; (iv) .75; (v) 1.0 ?
(b) On the bases of your answer to (a) what is the trade-off
between risk and return, that is how does expected return
vary with beta?
Suppose that the S&P 500, with a beta of 1.0, has an expected return
of 13 percent and T-bills provide a risk-free return of 5 percent.
- What would be the expected return and beta of portfolios
constructed from these two assets with weights in the S&P 500 of (i)
0; (ii) .25; (iii) .5; (iv) .75; (v) 1.0?
- Based on your answer to (a), what is the trade-off between risk and
return, that is, how does expected return vary with beta?
- What does your answer to (b) have to do with the security market
line relationship?
A share of stock with a beta of 0.67 now sells for $51. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 4%, and the market risk premium is 9%.
(a)
The opportunity cost of capital = 10.03%
The stock is a bad buy and the investors will sell the stock.
(b)
If CAPM holds, the fair price of the stock today= $50.90
Consider the following two scenarios for the economy and the returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.
Rate of Return
Scenario Market Aggressive
Stock A Defensive
Stock D
Bust −8% −10% −6%
Boom 25 30 21
- Find the beta of each stock. (Round your answers to 2 decimal places.)
Beta
Stock A
Stock D
- If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock. (Round your answers to 2 decimal places.)
Expected
Rate of Return
Market portfolio %
Stock A %
Stock D %
- If the T-bill rate is 5%, what does the CAPM say about the fair expected rate of return on the two stocks?(Do not round intermediate calculations. Round your answers to 2 decimal places.)
Expected
Rate of Return
Stock A %
Stock D %
- Which stock seems to be a better buy on the basis of your answers to (a) through (c)?
Stock A
Stock D
The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of 1.5, what is its expected return?
- 17%
- 12%
- 19.5%
- 24.5%
A stock has a beta of 0.9, the expected return on the market is 13 percent, and the risk-free rate is 6 percent. What must the expected return on this stock be?
A stock has an expected return of 17 percent, the risk-free rate is 5.5 percent, and the market risk premium is 8 percent. What must the beta of this stock be?
- Problem 11-3 Real versus Nominal Returns (LO2)
You purchase 100 shares of stock for $25 a share. The stock pays a $2 per share dividend at year-end. What is the rate of return on your investment for the end-of-year stock prices listed below? What is your real (inflation-adjusted) rate of return? Assume an inflation rate of 5%. (Leave no cells blank – be certain to enter “0” wherever required. Negative values should be indicated by a minus sign. Do not round intermediate calculations. Round your “Real Rate of Return” answers to 2 decimal places.)
Rate of Return Real Rate of Return
- $23 0 % -4.76 %
- $25 8 % 2.86 %
- $28 20 % 14.29 %
________________________________________
3.
Here are stock market and Treasury bill percentage returns between 2006 and 2010:
Year Stock Market Return T-Bill Return
2006 16.47 5.30
2007 6.41 5.16
2008 −37.93 1.80
2009 28.90 0.60
2010 17.96 0.62
________________________________________
. What was the risk premium on common stock in each year? (Negative values should be indicated by a minus sign. Round your answers to 2 decimal places.)
- What was the average risk premium? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Average risk premium 3.67 %
- What was the standard deviation of the risk premium? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Standard deviation of the risk premium 23.41 %
4.
- Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?
Yes
- Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Round your answers to 1 decimal place.)
Expected Rate
of Return Standard
Deviation
Stocks 15.0 % 15.5 %
Bonds 12.6 % 5.5 %
________________________________________
- Which investment would you prefer?
Stocks
5.
roblem 11-18 Portfolio Analysis (LO3)
Rate of Return
Scenario Probability Stocks Bonds
Recession .30 −7 % +18 %
Normal economy .60 +20 +10
Boom .10 +26 +3
________________________________________
Consider a portfolio with weights of .7 in stocks and .3 in bonds.
- What is the rate of return on the portfolio in each scenario? (Do not round intermediate calculations. Round your answers to 1 decimal place.)
Scenario Rate of Return
Recession 0.5 %
Normal economy 17.0 %
Boom 19.1 %
________________________________________
- What are the expected rate of return and standard deviation of the portfolio? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Expected rate of return 12.26 %
Standard deviation 7.72 %
________________________________________
- Which investment would you prefer?
Portfolio
6.
Problem 11-22 Risk and Return (LO2, 4)
A stock will provide a rate of return of either −21% or +32%.
- If both possibilities are equally likely, calculate the expected return and standard deviation. (Do not round intermediate calculations. Round your answers to 1 decimal place.)
Expected return 5.5 %
Standard deviation 26.5 %
________________________________________
- If Treasury bills yield 5.5% and investors believe that the stock offers a satisfactory expected return, what must the market risk of the stock be?
Market risk 0%
7
Problem 12-7 CAPM and Expected Return (LO2)
The risk-free rate is 6% and the expected rate of return on the market portfolio is 13%.
- Calculate the required return of a security with a beta of 1.34 and an expected rate of return of 17%. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Required return 15.38 %
- Is the security overpriced or underpriced?
Underpriced
8.
Problem 12-12 CAPM and Cost of Capital (LO3)
The Treasury bill rate is 5% and the market risk premium is 8%.
Project Beta Internal Rate of Return, %
P 0.70 12
Q 0 8
R 1.00 14
S 0.10 9
T 1.10 13
________________________________________
- What are the project costs of capital for new ventures with betas of .45 and 1.45? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Beta Cost of Capital
0.45 8.60 %
1.45 16.60 %
________________________________________
- Which of the following capital investments have positive NPVs? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a answer and double click the box with the question mark to empty the box for a wrong answer.)
P
Q
T
R
S
- Problem 12-19 CAPM and Valuation (LO3)
You are considering the purchase of real estate that will provide perpetual income that should average $65,000 per year. How much will you pay for the property if you believe its market risk is the same as the market portfolio’s? The T-bill rate is 5%, and the expected market return is 8.0%.
If the systematic risk were comparable to that of the market, the discount rate would be 8.0%.
10.
Problem 12-22 CAPM and Expected Return (LO2)
Stock A has a beta of .2, and investors expect it to return 5%. Stock B has a beta of 1.8, and investors expect it to return 17%. Use the CAPM to find the expected rate of return and the market risk premium on the market. (Do not round intermediate calculations. Round your answers to 1 decimal place.)
Expected rate of return 11.0 %
Market risk premium 7.5 %
________________________________________
11.
Problem 12-29 CAPM (LO2)
We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative, −.2.
- If the interest rate on Treasury bills is 6% and the expected return on the market portfolio is 16%, what is the expected return on the shares of the law firm according to the CAPM?
Expected return 4 %
- Suppose you invested 80% of your wealth in the market portfolio and the remainder of your wealth in the shares in the law firm. What would be the beta of your portfolio? (Round your answer to 2 decimal places.)
Portfolio beta .76
12.
Problem 13-1 Cost of Debt (LO2)
Micro Spinoffs, Inc., issued 10-year debt a year ago at par value with a coupon rate of 8%, paid annually. Today, the debt is selling at $1,180. If the firm’s tax bracket is 40%, what is its after-tax cost of debt? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
After-tax cost of debt 3.25 %
13.
Problem 13-2 Cost of Preferred Stock (LO2)
Micro Spinoffs has preferred stock outstanding. The stock pays a dividend of $4 per share, and the stock sells for $40. What is the return on preferred stock?
Return on preferred stock 10 %
Micro Spinoffs, Inc., issued 10-year debt a year ago at par value with a coupon rate of 6%, paid annually. Today, the debt is selling at $1,060. The firm’s tax bracket is 30%.
Micro Spinoffs also has preferred stock outstanding. The stock pays a dividend of $6 per share, and the stock sells for $40.
Micro Spinoffs’s cost of equity is 17%. What is its WACC if equity is 60%, preferred stock is 10%, and debt is 30% of total capital? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
WACC 12.78 %
- Problem 13-5 Calculating WACC (LO3)
Reactive Industries has the following capital structure. Its corporate tax rate is 30%.
Security Market Value Required Rate
of Return
Debt $20 million 2%
Preferred stock 30 million 4
Common stock 50 million 8
________________________________________
What is its WACC? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
WACC 5.48 %
- Problem 13-14 Cost of Equity (LO2)
Bunkhouse Electronics is a recently incorporated firm that makes electronic entertainment systems. Its earnings and dividends have been growing at a rate of 20%, and the current dividend yield is 2%. Its beta is 1.1, the market risk premium is 9%, and the risk-free rate is 4%.
a-1. Calculate the firm’s cost of equity by using the Dividend Discount Model.
Cost of equity 22 %
a-2. Calculate the firm’s cost of equity by using the CAPM. (Do not round intermediate calculations. Round your answer to 1 decimal place.)
Cost of equity 13.9 %
- Which estimate seems more reasonable to you?
CAPM