8. Which of the following does the trade-off theory predict? A. Bankruptcy costs mean having no debt is always optimal. B. Reducing leverage always reduces firm value. C. In the long run the firm's capital structure converges to the optimal one. D. None of the above.
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- (Figure in attachment!!!) Problem 4: For each of the following statements, judge if it is true or false, andprovide a detailed explanation behind your answers.a) Roll’s critique is that the market is never truly in equilibrium and henceone can never truly test whether the CAPM holds.b) The figure below shows the risk and expected return of 4 given assets.Consider an investor with “Mean-Variance” preferences, and the statement:“If the investor is indifferent between assets A and D, then she prefers Cto B; but if she is indifferent between B and C, she prefers A to D.”.c) Suppose you make a “scatter plot”, each point representing a pair ofcontemporaneous returns from a time series of returns on the marketportfolio and a single asset. If the CAPM holds, you would expect all points to line up perfectly on a straight line, the slope of which is theasset’s beta.PS: (Problem 4 figure in attachment!!!)When a firm has less current assets to pay off its current liabilities, it has ______ liquidity risk. Such a firm is likely to have _____ returns. Question 32 options: 1) lower, higher 2) lower, lower 3) higher, higher 4) higher, lower3.If the interest rate on debt is lower than ROA, then a firm will __________ by increasing the useof debt in the capital structure.a. increase the ROE b. not change the ROE c. decrease the ROEd. change the ROE in an indeterminable manner e. none of the above
- (1) Why is the risk-free return independent of the state of the economy? Do T-bills promise a completely risk-free return? (2) Why are High Tech’s returns expected to move with the economy whereas Collections’ are expected to move counter to the economy? Calculate the expected rate of return on each alternative and fill in the row for in the table. You should recognize that basing a decision solely on expected returns is appropriate only for risk-neutral individuals. Because the beneficiaries of the trust, like virtually everyone, are risk averse, the riskiness of each alternative is an important aspect of the decision. One possible measure of risk is the standard deviation of returns. (1) Calculate this value for each alternative, and fill in the row for σ in the table. (2) What type of risk does the standard deviation measure? (3) Draw a graph that shows roughly the shape of the probability distributions for High Tech, U.S. Rubber, and T-bills. Suppose you suddenly remembered that…According to the Capital Asset Pricing Model (CAPM), an asset with negative beta: a. Cannot exist b. Is expected to earn a negative return c. Should be short sold d. Will not be included in the market portfolio e. None of the above5.(True or False) Risk shifting refers to a situation in which management of a firm with risky debt cannot fund a positive NPV project with equity because equityholders understand that some of the returns of the positive NPV project go to debtholders
- A Moving to another question will save this response. Question 6 According to the risk shifting (or asset substitution) hypothesis Shareholders are keen to take excessively risky projects as they do not internalize the negative externality to bondholders O Firms should never pay dividends O Companies become too conservative in their investment when debt levels are such that bankruptcy is a likely outcome O It is always optimal to reduce leverage as this reduces expected bankruptcy costs A Moving to another question will save this response. ipeg WhatsApp Image..jpeg WhatsApp Image.jpeg WhatsApp Image...jpeg WhatsApp Image..jpeg WhatsApp Im. Shot on vivo Z1x 00 16°C Mostly cloudy WIDE Vivo Al camera(b) Assume that Modigliani-Miller Propositions 1 and 2 hold. Ex- plain carefully why the conclusion of each of the following argu- ments is incorrect: (i) As a firm borrows more and debt becomes risky, both share- holder and bondholders demand higher rates of return. Thus, by reducing its debt ratio, a firm can reduce both the cost of debt and the cost of equity. (ii) As leverage increases, the ratio of the market value of a firm's equity to income (after debt interest) increases.The Arbitrage Pricing Theorem states that:a)If arbitrage opportunities do not exist then the returns of all assets are driven by a set of common factors.b)Arbitrage portfolios are impossible.c)The expected return of any arbitrage portfolio is zero.d)The common constant factor is the risk-free asset
- 16. Which statement is not true regarding the Capital Market Line (CML)? a. The CML is the line from the risk free rate through the market portfolio. b. The CML is the best attainable capital allocation line. c. The CML is also called the security market line. d. The CML always has a positive slope. e. Not all of these statements are true.Is the following sentence true or false? Please explain. The cost of new equity (re) could possibly be lower than the cost of reinvested earnings (rs) if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount.All of the following statements about an efficient market are correct EXCEPT: a. All financial transactions have an NPV of equal to zero b. A skilled individual may have sustainable above market returns c. The investor is compensated properly for risk borne d. The investor does not receive abnormal returns consistently