Fnce 451 Test Bank Chapter 12
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Test Bank Chapter 12
Financial Controllership 1 (Humber College)
Studocu is not sponsored or endorsed by any college or university
Test Bank Chapter 12
Financial Controllership 1 (Humber College)
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
Chapter 12
An Alternative View of Risk and Return: The Arbitrage Pricing Theory
Multiple Choice Questions
1. Both the APT and the CAPM imply a positive relationship between expected return and risk. The APT views risk: A. very similarly to the CAPM via the beta of the security.
B. in terms of individual inter-security correlation versus the beta of the CAPM.
C.
via the industry wide or market-wide factors creating correlation between securities versus the CAPM beta.
D. the standardized deviation of the covariance.
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Blooms: Remember
Difficulty: Easy
Topic: 12-06 Betas and Expected Returns
2. In the equation R = + U, the three symbols stand for: A. average return, expected return, and unexpected return.
B. required return, expected return, and unbiased return.
C.
actual return, expected return, and unexpected return.
D. required return, expected return, and unbiased risk.
E. risk, expected return, and unsystematic risk.
Blooms: Understand
Difficulty: Easy
Topic: 12-01 Factor Models: Announcements, Surprises, and Expected Returns
12-1
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
3. Which of the following is true about the impact on market price of a security when a company makes an announcement and the market has discounted the news? A. The price will change a great deal; even though the impact is primarily in the future, the future value is discounted to the present.
B. The price will change little, since the impact is primarily in the future.
C. The price will change little, since the market considers this information unimportant.
D. The price will change little, since the market considers this information untrue.
E.
The price will change little, since the market has already included this information in the security's price.
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Blooms: Understand
Difficulty: Easy
Topic: 12-01 Factor Models: Announcements, Surprises, and Expected Returns
4. Shareholders discount many corporate announcements because of their prior expectations. If an announcement causes the price to change it will mostly be driven by: A. the expected part of the announcement.
B. market inefficiency.
C.
the innovation or unexpected part of the announcement.
D. the systematic risk.
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Blooms: Remember
Difficulty: Medium
Topic: 12-02 Risk: Systematic and Unsystematic
5. The unexpected return on a security, U, is made up of: A. market risk and systematic risk.
B.
systematic risk and idiosyncratic risk.
C. idiosyncratic risk and unsystematic risk.
D. expected return and market risk.
E. expected return and idiosyncratic risk.
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Blooms: Remember
Difficulty: Easy
Topic: 12-02 Risk: Systematic and Unsystematic
12-2
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
6. Systematic risk is defined as: A. a risk that specifically affects an asset or small group of assets.
B.
any risk that affects a large number of assets.
C. any risk that has a huge impact on the return of a security.
D. the random component of return.
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Blooms: Remember
Difficulty: Easy
Topic: 12-02 Risk: Systematic and Unsystematic
7. In normal market conditions or when the market is rising if a security has a negative beta: A. the security always has a positive return.
B. the security has an expected return above the risk-free return.
C.
the security has an expected return less than the risk-free rate.
D. the security has an expected return equal to the market portfolio.
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Blooms: Understand
Difficulty: Medium
Topic: 12-03 Systematic Risk and Betas
8. If company A makes a new product discovery and their stock rises 5% this will have: A. no effect on Company B's stock price because it is a systematic risk element.
B.
no effect on Company B's stock price because it is an unsystematic risk element.
C. a large effect on Company B's stock price because it is a systematic risk element.
D. a large effect on Company B's stock price because it is an unsystematic risk element.
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Blooms: Understand
Difficulty: Easy
Topic: 12-02 Risk: Systematic and Unsystematic
12-3
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
9. The term Corr(
R
,
T
) = 0 tells us that: A. the error terms of company R and T are 0.
B.
the unsystematic risk of companies R and T is unrelated or uncorrelated.
C. the correlation between the returns of companies R and T is greater than zero.
D. the systematic risk companies R and T is unrelated.
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Blooms: Understand
Difficulty: Medium
Topic: 12-02 Risk: Systematic and Unsystematic
10. The systematic response coefficient for productivity,
P
, would produce an unexpected change in any security return of ________ if the expected rate of productivity was 1.5% and the actual rate was 2.25%. A.
0.75(
P
)%
B. -0.75(
P
)%
C. 2.25(
P
)%
D. -2.25%
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Blooms: Analyze
Difficulty: Medium
Topic: 12-03 Systematic Risk and Betas
11. If the expected rate of inflation was 3% and the actual rate was 6.2%; the systematic response coefficient from inflation,
I
, would result in a change in any security return of: A. 9.2%.
B.
3.2
I
%.
C. -3.2
I%.
D. 3.0%.
E. 6.2
I%.
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Blooms: Analyze
Difficulty: Easy
Topic: 12-03 Systematic Risk and Betas
12-4
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
12. A factor is a variable that: A.
affects the returns of risky assets in a systematic fashion.
B. affects the returns of risky assets in an unsystematic fashion.
C. correlates with risky asset returns in a unsystematic fashion.
D. does not correlate with the returns of risky assets in an systematic fashion.
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Blooms: Understand
Difficulty: Easy
Topic: 12-03 Systematic Risk and Betas
13. In a portfolio of risky assets the response to a factor, F
i
, can easily be determined by: A.
summing the weighted
i
s and multiplying by the innovation in F
i
.
B. summing the F
i
s.
C. adding the average weighted expected returns.
D. Summing the weighted random errors.
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Blooms: Understand
Difficulty: Medium
Topic: 12-04 Portfolios and Factor Models
14. Based on a multi-factor APT model, the concept of portfolio diversification is to minimize
which one of the following? A. weighted average of betas
B. weighted average of betas
F
C. F
D.
weighted average of unsystematic risks
E. weighted average of expected returns
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Blooms: Understand
Difficulty: Medium
Topic: 12-04 Portfolios and Factor Models
12-5
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
15. In the One Factor (APT) Model, the characteristic line to estimate
i passes through the origin, unlike the estimate used in the CAPM because: A. the relationship is between the actual return on a security and the market index.
B. the relationship measures the change in the security return over time versus the change in the market return.
C. the relationship measures the change in excess return on a security versus GNP.
D.
the relationship measures the change in excess return on a security versus the change in the
factor about its mean of zero.
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Blooms: Understand
Difficulty: Hard
Topic: 12-03 Systematic Risk and Betas
16. The betas along with the factors in the APT adjust the expected return for: A. calculation errors.
B. unsystematic risks.
C. spurious correlations of factors.
D.
differences between actual and expected levels of factors.
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Blooms: Remember
Difficulty: Hard
Topic: 12-03 Systematic Risk and Betas
17. The single factor APT model that resembles the market model uses _____________ as the
single factor. A. arbitrage fees
B. GNP
C. the inflation rate
D.
the market return
E. the risk-free return
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Blooms: Remember
Difficulty: Easy
Topic: 12-03 Systematic Risk and Betas
12-6
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
18. Assume that the single factor APT model applies and a portfolio exists such that 2/3 of the
funds are invested in Security Q and the rest in the risk-free asset. Security Q has a beta of 1.5. The portfolio has a beta of: A. 0.00.
B. 0.50.
C. 0.75.
D.
1.00.
E. 1.50.
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Blooms: Analyze
Difficulty: Medium
Topic: 12-03 Systematic Risk and Betas
19. For a diversified portfolio including a large number of stocks,: A. the weighted average expected return goes to zero.
B. the weighted average of the betas goes to zero.
C.
the weighted average of the unsystematic risk goes to zero.
D. the return of the portfolio goes to zero.
E. the return on the portfolio equals the risk-free rate.
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Blooms: Understand
Difficulty: Easy
Topic: 12-04 Portfolios and Factor Models
20. Which of the following statements is true? A. A well-diversified portfolio has negligible systematic risk.
B.
A well-diversified portfolio has negligible unsystematic risk.
C. An individual security has negligible systematic risk.
D. An individual security has negligible unsystematic risk.
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Blooms: Understand
Difficulty: Easy
Topic: 12-04 Portfolios and Factor Models
12-7
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
21. The acronym APT stands for: A. Above Par Terms.
B. Absolute Profit Technique.
C.
Arbitrage Pricing Theory.
D. Asset Puting Theory.
E. Assured Price Techniques.
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Blooms: Remember
Difficulty: Easy
Topic: 12-06 Betas and Expected Returns
22. The acronym CAPM stands for: A.
Capital Asset Pricing Model.
B. Certain Arbitrage Pressure Model.
C. Current Arbitrage Prices Model.
D. Cumulative Asset Price Model.
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Blooms: Remember
Difficulty: Easy
Topic: 12-06 Betas and Expected Returns
23. Assuming that the single factor APT model applies, the beta for the market portfolio is: A. zero.
B.
one.
C. the average of the risk free beta and the beta for the highest risk security.
D. impossible to calculate without collecting sample data.
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Blooms: Remember
Difficulty: Easy
Topic: 12-04 Portfolios and Factor Models
12-8
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
24. Suppose the JumpStart Corporation's common stock has a beta of 0.8. If the risk-free rate is 4% and the expected market return is 9%, the expected return for JumpStart's common stock is: A. 3.2%.
B. 4.0%.
C. 7.2%.
D.
8.0%.
E. 9.0%.
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Blooms: Analyze
Difficulty: Easy
Topic: 12-04 Portfolios and Factor Models
25. Suppose the MiniCD Corporation's common stock has a return of 12%. Assume the risk-
free rate is 4%, the expected market return is 9%, and no unsystematic influence affected Mini's return. The beta for MiniCD is: A. 0.89.
B.
1.60.
C. 2.40.
D. 3.00.
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Blooms: Analyze
Difficulty: Medium
Topic: 12-03 Systematic Risk and Betas
26. A security that has a beta of zero will have an expected return of: A. zero.
B. the market risk premium.
C.
the risk free rate.
D. less than the risk free rate but not negative.
E. less than the risk free rate which can be negative.
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Blooms: Remember
Difficulty: Medium
Topic: 12-05 Portfolios and Diversification
12-9
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
27. A criticism of the CAPM is that it: A. ignores the return on the market portfolio.
B. ignores the risk-free return.
C.
requires a single measure of systematic risk.
D. utilizes too many factors.
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Blooms: Remember
Difficulty: Easy
Topic: 12-05 Portfolios and Diversification
28. To estimate the cost of equity capital for a firm using APT or CAPM, it is necessary to have: A. company financial leverage, beta, and the market risk premium.
B. company financial leverage, beta, and the risk-free rate.
C. beta, company financial leverage, and the industry beta.
D. beta, company financial leverage, and the market risk premium.
E.
beta, the risk-free rate, and the market risk premium.
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Blooms: Remember
Difficulty: Easy
Topic: 12-06 Betas and Expected Returns
29. Three factors likely to occur in the APT model are: A. unemployment, inflation, and current rates.
B.
inflation, GNP, and interest rates.
C. current rates, inflation and change in housing prices.
D. unemployment, college tuition, and GNP.
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Blooms: Remember
Difficulty: Medium
Topic: 12-04 Portfolios and Factor Models
12-10
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
30. To estimate the required return for a security using APT or CAPM, it is necessary to have: A. last period's return, beta, and the standard deviation.
B. last period's return, beta, and the risk-free rate.
C.
beta, the market risk premium, and the risk-free rate.
D. beta, last period's return, and the standard deviation.
E. beta, last period's return, and the market risk premium.
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Blooms: Remember
Difficulty: Easy
Topic: 12-06 Betas and Expected Returns
31. An advantage of the APT over CAPM is: A. APT can handle multiple factors.
B. if the factors can be properly identified, the APT may have more explanation/predictive power for returns.
C. the APT forces unsystematic risk to be negative to offset systematic risk; thus making the total portfolio risk free, allowing for an arbitrage opportunity for the astute investor.
D.
APT can handle multiple factors; and if the factors can be properly identified, the APT may
have more explanation/predictive power for returns.
E. All of these.
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Blooms: Remember
Difficulty: Medium
Topic: 12-06 Betas and Expected Returns
12-11
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
32. Suppose that we have identified three important systematic risk factors given by exports, inflation, and industrial production. In the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by
EX
= 1.8,
I
= 0.7, and
IP
= 1.0.
If the expected return on the stock is 6%, and no unexpected news concerning the stock surfaces, calculate the stock's total return. A. 2.95%
B.
4.95%
C. 6.55%
D. 7.40%
E. 8.85%
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Blooms: Analyze
Difficulty: Medium
Topic: 12-06 Betas and Expected Returns
33. Suppose that we have identified three important systematic risk factors given by exports, inflation, and industrial production. In the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by
EX
= 1.8,
I
= 0.7, and
IP
= 1.0.
Calculate the stock's total return if the company announces that they had an industrial accident
and the operating facilities will close down for some time thus resulting in a loss by the company of 7% in return. Assume expected return on the stock is 6%. A. -4.05%
B.
-2.05%
C. 4.55%
D. 0.40%
E. 1.85%
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Blooms: Analyze
Difficulty: Medium
Topic: 12-06 Betas and Expected Returns
12-12
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
34. Suppose that we have identified three important systematic risk factors given by exports, inflation, and industrial production. In the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by
EX = 1.8,
I = 0.7, and
IP =
1.0.
What would the stock's total return be if the actual growth in each of the factors was equal to growth expected? Assume no unexpected news on the patent. Assume expected return on the stock is 6%. A. 4%
B. 5%
C.
6%
D. 7%
E. 8%
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Blooms: Analyze
Difficulty: Medium
Topic: 12-06 Betas and Expected Returns
35. Which of the following statements is/are true? A. Both APT and CAPM argue that expected excess return must be proportional to the beta(s).
B. APT and CAPM are the only approaches to measure expected returns in risky assets.
C. Both CAPM and APT are risk-based models.
D. Both APT and CAPM argue that expected excess return must be proportional to the beta(s); and APT and CAPM are the only approaches to measure expected returns in risky assets.
E.
Both APT and CAPM argue that expected excess return must be proportional to the beta(s);
and Both CAPM and APT are risk-based models.
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Blooms: Remember
Difficulty: Medium
Topic: 12-06 Betas and Expected Returns
12-13
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
36. Financial models used to describe returns are based either on a theoretical construct or parametric methods. Parametric models rely on: A. security betas explaining systematic factor relationships.
B.
finding regularities and relations in past market data.
C. there being no true explanations of pricing relationships.
D. always being able to find the exception to the rule.
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Blooms: Understand
Difficulty: Hard
Topic: 12-07 The Linear Relationship
37. A growth stock portfolio and a value portfolio might be characterized A.
each by their P/E relative to the index P/E; high P/E for growth and lower for value.
B. as earning a high rate of return for a growth security and a low rate of return for value security irrespective of risk.
C. low unsystematic risk and high systematic risk respectively.
D. moderate systematic risk and zero systematic risk respectively.
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Blooms: Understand
Difficulty: Medium
Topic: 12-07 The Linear Relationship
38. Style portfolios are characterized by: A.
their stock attributes; P/Es less than the market P/E are value funds.
B. their systematic factors, higher systematic factors are benchmark portfolios.
C. their stock attributes; higher stock attribute factors are benchmark portfolios.
D. their systematic factors, P/Es greater than the market are value portfolios.
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Blooms: Understand
Difficulty: Medium
Topic: 12-07 The Linear Relationship
Short Answer Questions
12-14
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
39. An investor is considering the three stocks given below:
Stock Return
Expected
Beta
A
6.0%
-0.10
B
13.3%
2.10
C
9.2%
0.75%
Market Portfolio
10.0%
1.00
T-Bills
7.0%
0.00
Calculate the expected return and beta of a portfolio equally weighted between stocks B and C. Demonstrate that holding stock A actually reduces risk by comparing the risk of a portfolio equally weighted between stock B and T-Bills with a portfolio equally weighted between stock B and A. Stock B and C: Rp = .5(13.3%) + .5(9.2%) = 11.25%
Stock B and C:
p = .5(2.1) + .5(0.75) = 1.425
Stock B and T-bills:
B&TBILL = .5(2.1) + .5(0) = 1.05
Stock's B and A:
B&A = .5(2.1) + .5(-0.1) = 1.00
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Blooms: Analyze
Difficulty: Easy
Topic: 12-05 Portfolios and Diversification
40. Explain the conceptual differences in the theoretical development of the CAPM and APT. CAPM depends on efficient sets notions incorporate R
f
to get separation principle the APT adds factors until there is no correlation between unsystematic risks of securities both show unsystematic risk approaches zero and systematic risks remain
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Blooms: Apply
Difficulty: Hard
Topic: 12-06 Betas and Expected Returns
12-15
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory
41. You have a 3 factor model to explain returns. Explain what a factor represents in the context of the APT? Each factor is multiplied by a
what do these represent and how do they relate to the actual return? Factor variable that explains some of the return measures the unexpected change in some underlying "economic" data
systematic risk of a security to a Factor measure security response to a Factor change explain how actual return varies from the expected return by the magnitude of
times the value of the factor.
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Blooms: Apply
Difficulty: Hard
Topic: 12-06 Betas and Expected Returns
42. Identify at least two accounting measures that are used in empirical asset pricing models and explain how these measures can be used to identify assets that are expected to have higher
returns in the future. Two common measures used in empirical models are PE and M/B, or the price-earnings ratio and the market-to-book ratio. A low value in either of these measures as compared to the average security would tend to identify securities that can be expected to produce higher returns in the future.
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Blooms: Apply
Difficulty: Hard
Topic: 12-07 The Linear Relationship
12-16
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1. Which of the following are acceptable criteria for determining the weights in the weighted average cost of capital?
O Market value of the capital structure and historical costs of financing
Market value of the capital structure and the target mix of debt and equity
Using the after-tax cost of debt and the market value of the capital structure
Using the book value of the capital structure and the prior level of debt and equity
2. When a company increases its degree of financial leverage,
the equity beta of the company falls
the systematic risk of the company falls
the unsystematic risk of the company falls
the standard deviation of returns on the equity of the company rises
3. Calculate the degree of financial leverage for a firm with EBIT of $6,000,000, fixed cost of…
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Quèstion 7
What is the other name for fim-specific risk?
O Systematic risk
O Market risk
O Micro-cap risk
O Undiversifiable risk
O Diversifiable risk
A Moving to another question will save this response.
Mac
20
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DO0 F4
esc
F1
F2
#3
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2
4
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Fill in the blank with multiple choice finance homework question
10._____ markets and ______ markets are classifications of financial markets.
Spot; future.
Money; capital.
Long-term; short-term.
Organized; over-the-counter.
Corporate; personal.
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A.Interest rates are important in finance, and it is important for all students to understand the basics of how they are determined. However, the chapter really has two aspects that become clear when we try to write test questions and problems for the chapter. First, the material on the fundamental determinants of interest rates - the real risk-free rate plus a set of premiums - is logical and intuitive, and easy in a testing sense. However, the second set of material, that dealing with the yield curve and the relationship between 1-year rates and longer-term rates, is more mathematical and less intuitive, and test questions dealing with it tend to be more difficult, especially for students who are not good at math.
As a result, problems on the chapter tend to be either relatively easy or relatively difficult, with the difficult ones being as much exercises in algebra as in finance. In the test bank for prior editions, we tended to use primarily difficult problems that addressed…
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« Question 36 of 50
Which of the following statements is CORRECT?
O a. Money markets are markets for long-term debt and common stocks.
O b. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks.
O c. The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market.
d. While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other partles.
O e. A liquid security is a security whose value is derived from the price of some other "underlying" asset.
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Which of the following is true of Behavioral Finance? Question 24 options: 1) It is a study of how
sociological and economic factors drive investor buy-and-sell decisions 2) It argues that investors
are always rational in their investment decision and that price anomalies are due to weak form
market efficiency 3) It argues that investors often make decisions based on emotions and biases 4) It
is a study of how market overreaction and underreaction are explained by the efficient market
hypothesis
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