Exam 3 Prep Flashcards
Which of the following is the best example of systematic risk?
The Federal Reserve tightens the money supply to fight inflation which causes the interest rates to rise.
The risk-return tradeoff principle in finance is:
the expectation of receiving higher returns for higher risk investments.
Which of the following is the best description of systematic risk?
Any risk that will impact the value of all assets simultaneously.
Asset; Expected return; beta
A: 16%; 1.2
B: 14%; 1.0
C: 21%; 1.6
What is the beta of a portfolio consisting of 25% invested in Asset A, 45% invested in asset B, and 30% in asset C?
1.23
You purchased Hobo Hats stock last year for $60 a share. Today, you received $2 a share dividend and immediately sold the stock for $63. Your realized return, or holding period return, was
8.33%
An asset with a beta of 1.6 will have an expected return of ________ when the risk-free rate is 4% and the expected return on the market is 12%.
16.8%
The beta for a portfolio is determined by calculating
a weighted average of individual stock betas where the weight equals the percentage invested in each stock.
the correlation coefficient is a measure of
the degree of variation between asset returns.
Under the capital asset pricing model, the relevant risk is
systematic risk
the equity market risk premium is the
return of equities over T-bills
Which of the following correlation coefficients would generate the most benefit in terms of risk reduction for a 2-asset portfolio that consists of 40% in Asset A and 60% in Asset B?
-0.65
What is a percentage return of stock that was purchased at $45 and sold one year later for $55 if the stock also paid $3 in dividends over that time period?
28.9%
A stock’s holding period return represents
the total return over a specific period through buying and selling an asset.
____ risk is the only risk that matters to investors with broadly diversified portfolios.
systematic
According to the security market line, a security with a beta of 1.5 should provide a risk premium that is ______ times the risk premium existing for the market as a whole.
1.5
the correlation coefficient is a measure of
the degree of variation between asset returns.
if the required return for a security is 15% and the risk-free rate is 6%, the risk premium is
9%
You are considering two securities. Security A has a historical average annual return of 7% and a standard deviation of 3%. Security B has a historical average annual return of 7% and a standard deviation of 9%. From this information you can conclude that:
Security B is more risky than Security A
firm-specific risk is the
diversifiable risk of an asset.
The __________ is the rate of return a firm must earn on its investment in order to maintain the market value of its stock.
cost of capital
The cost of retained earnings is equivalent to the cost of __________.
common stock
The WACC represents the average __________ for the firm.
cost of financing
The firm’s optimal mix of debt and equity is called its:
target capital structure
The approximate before-tax cost of debt for a 20-year, 9%, $1,000 par value bond selling for $950 is __________.
9.57%
Which of the following inputs is needed when you use the constant dividend growth model (CDGM) to estimate the cost of equity?
current stock price
A firm has issued 8% preferred stock, which sold for $100 per share par value. The flotation costs of the stock equaled $3 and the firm’s marginal tax rate is 40%. The cost of the preferred stock is;
8.25%
The specific cost of each source of long-term financing is based on __________ costs.
after-tax and current
A firm has determined its cost of each source of capital and its optimal capital structure which is comprised of the following sources;
Long-term debt = 45%, after-tax cost = 7%
Preferred stock = 15%, after-tax cost = 10%
Common stock equity = 40%, after-tax cost = 14%
The weighted average cost of capital for this firm is;
10.25%
The cost of debt used in the WACC is adjusted lower __________.
since there is a tax shield associated with paying interest
The stock of Canadian Ski Wear is currently trading at $45 a share and the equity beta of the company is estimated to be 1.3. The company is expected to pay a dividend of $1.50 a share next year, and this dividend is expected to grow at a rate of 4% per year. The rate on the 10-year U.S. Treasury bond is 4% and you estimate the market risk premium to be 5%. Using the CAPM, what is the company’s cost of equity?
10.5%
The debt issued by Coastal Construction has a coupon rate of 5% and a yield to maturity of 6.2%. The company is in the 25% tax bracket. Coastal Construction’s effective cost of debt is:
4.65%
A firm has a beta of 0.90. If market returns are 12% and the risk-free rate is 4%, the estimated cost of equity is __________.
11.2%
The stock of Canadian Ski Wear is currently trading at $45 a share and the equity beta of the company is estimated to be 1.3. The company is expected to pay a dividend of $1.50 a share next year, and this dividend is expected to grow at a rate of 4% per year. The rate on the 10-year U.S. Treasury bond is 4% and you estimate the market risk premium to be 5%. Using the CDGM, what is the company’s cost of equity?
7.3%
A tax adjustment must be made in determining the cost of:
long-term debt
the effective cost of debt is
less than the return paid to debt holders due to tax benefits of interest paid
Which of the following inputs is needed when you use the constant dividend growth model (CDGM) to estimate the cost of equity?
current stock price
The cost of new preferred stock in the WACC is computed as the preferred dividend divided by the __________.
net proceeds from the sale of the preferred.
