Corporate Finance Chapter 11 Flashcards
Corporate Finance Chapter 11
Market interest rates have risen substantially in the five years since an investor purchased
Treasury bonds that were offering a 7 percent return. If the investor sells now she is likely to
receive:
A. greater than a 7 percent total return.
B. less than a 7 percent total return.
C. a 7 percent total rate of return.
D. a 7 percent nominal return but less than a 7 percent real return.
B. less than a 7 percent total return.
Which of the following risks would be classified as a unique risk for an auto manufacturer?
A. interest rates
B. steel prices
C. business cycles
D. foreign exchange rates
B. steel prices
The risk premium that is offered on common stock is equal to the:
A. expected return on the stock.
B. real rate of return on the stock.
C. excess of expected return over a risk-free return.
D. expected return on the S&P 500 index.
C. excess of expected return over a risk-free return.
Which of the following firms is likely to exhibit the least macro risk exposure?
A. furniture manufacturer
B. oil driller
C. dog food processor
D. auto manufacturer
C. dog food processor
Treasury bonds have provided a higher historical return than Treasury bills, which can be attributed to:
A. greater default risk.
B. a higher level of unique risk.
C. greater price risk due to longer maturities.
D. the fact that they are less frequently traded than bills.
C. greater price risk due to longer maturities.
Strategy designed to reduce risk by spreading the portfolio across many investments. This is possible because assets possess two kinds of risks
Diversification
Economy-wide (macroeconomic) sources of risk that affect the overall stock market
Market risk
Risk factors affecting only that firm
Unique risk
a standardized measure of co-movement of the assets
Correlation coefficient
P > 0
positive correlation variables move in the same direction
P < 0
negative correlation variables move in the opposite direction
P = 0
no correlation
Covariance
The degree to which the returns on the two stocks move together
Macro risks
uncertain events affecting the entire securities market and economy. Examples: changes in interest rates, industrial production, inflation, exchange rates and energy cost, COVID-19
Standard deviation and variance are
measures of risk
For a well-diversified portfolio, what type of risk only matters?
market risk
Suppose a stock has a 30 percent probability of a -10 percent return, a 50 percent
probability of an 8 percent return, and a 20 percent probability of a 15 percent return. What is the standard deviation of returns?
A. 10.3
B. 4.0
C. 9.5
D. 91
C. 9.5
What is the expected return on a portfolio that will decline in value by 13 percent in a
recession, will increase by 16 percent in normal times, and will increase by 23 percent
during boom times if each scenario has equal likelihood?
A. 8.67 percent
B. 13.00 percent
C. 13.43 percent
D. 17.33 percent
A. 8.67 percent
If a stock is purchased for $25 per share and held one year, during which time a $3.50
dividend is paid and the price climbs to $28.25, the nominal rate of return is:
A. 13.00 percent.
B. 14.00 percent.
C. 23.01 percent
D. 27.00 percent.
D. 27.00 percent.
What percentage return is achieved by an investor who purchases a stock for $30, receives a $1.50 dividend, and sells the share one year later for $28.50?
A. -5 percent
B. 0 percent
C. 5 percent
D. 10 percent
B. 0 percent
What real rate of return is earned by a one-year investor in a bond that was purchased for $1,000, has an 8 percent coupon, and was sold for $960 when the inflation rate was 6
percent?
A. -1.89 percent
B. 1.92 percent
C. 5.66 percent
D. 11.47 percent
A. -1.89 percent
In a year in which common stocks offered an average return of 18 percent, Treasury bonds offered 10 percent and Treasury bills offered 7 percent, the risk premium for common stocks was:
A. 1 percent.
B. 3 percent.
C. 8 percent.
D. 11 percent.
D. 11 percent.
