Quiz III

Question 1

As long as the inflation rate is positive, the real rate of return on a security will be ____ the nominal rate of return.

Answer 1

less than

Question 2

Which one of the following statements is correct?

Answer 2

The greater the volatility of returns, the greater the risk premium.

Question 3

To convince investors to accept greater volatility, you must:

Answer 3

increase the risk premium.

Question 4

Which one of the following statements is correct concerning market efficiency?

Answer 4

A firm will generally receive a fair price when it issues new shares of stock.

Question 5

Efficient financial markets fluctuate continuously because:

Answer 5

the markets are continually reacting to new information.

Question 6

Inside information has the least value when financial markets are:

Answer 6

strong form efficient.

Question 7

According to theory, studying historical stock price movements to identify mispriced stocks:

Answer 7

is ineffective even when the market is only weak form efficient.

Question 8

If you excel in analyzing the future outlook of firms, you would prefer the financial markets be ____ form efficient so that you can have an advantage in the marketplace.

Answer 8

weak

Question 9

You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient.

Answer 9

semistrong

Question 10

The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient.

Answer 10

strong

Question 11

Which one of the following is a risk that applies to most securities?

Answer 11

systematic

Question 12

Which one of the following is represented by the slope of the security market line?

Answer 12

market risk premium

Question 13

Standard deviation measures which type of risk?

Answer 13

total

Question 14

Which one of the following is an example of systematic risk?

Answer 14

investors panic causing security prices around the globe to fall precipitously

Question 15

Unsystematic risk:

Answer 15

can be effectively eliminated by portfolio diversification.

Question 16

Which one of the following is an example of unsystematic risk?

Answer 16

consumer spending on entertainment decreased nationally

Question 17

Which one of the following statements is correct concerning unsystematic risk?

Answer 17

Eliminating unsystematic risk is the responsibility of the individual investor.

Question 18

Which one of the following risks is irrelevant to a well-diversified investor?

Answer 18

unsystematic risk

Question 19

Which of the following are examples of diversifiable risk?
I. earthquake damages an entire town
II. federal government imposes a $100 fee on all business entities
III. employment taxes increase nationally
IV. toymakers are required to improve their safety standards

Answer 19

I and IV only

Question 20

Which one of the following is the best example of a diversifiable risk?

Answer 20

a firms sales decrease

Question 21

Which one of the following indicates a portfolio is being effectively diversified?

Answer 21

a decrease in the portfolio standard deviation

Question 22

Systematic risk is measured by:

Answer 22

beta

Question 23

Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:

Answer 23

cost of debt

Question 24

A firm’s cost of capital:

Answer 24

depends upon how the funds raised are going to be spent.

Question 25

The capital structure weights used in computing the weighted average cost of capital:

Answer 25

are based on the market value of the firm’s debt and equity securities.

Question 26

The subjective approach to project analysis:

Answer 26

assigns discount rates to projects based on the discretion of the senior managers of a firm.

Question 27

Which one of the following statements is correct?

Answer 27

Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.

Question 28

When a firm has flotation costs equal to 7 percent of the funding need, project analysts should:

Answer 28

increase the initial project cost by dividing that cost by (1 - 0.07).

Question 29

The flotation cost for a firm is computed as:

Answer 29

the weighted average of the flotation costs associated with each form of financing.

Question 30

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business. The process this firm underwent is known as a:

Answer 30

reorganization.

Question 31

The absolute priority rule determines:

Answer 31

which parties receive payment first in a bankruptcy proceeding.

Question 32

The optimal capital structure has been achieved when the:

Answer 32

debt-equity ratio results in the lowest possible weighted average cost of capital.

Question 33

AA Tours is comparing two capital structures to determine how to best finance its operations. The first option consists of all equity financing. The second option is based on a debt-equity ratio of 0.45. What should AA Tours do if its expected earnings before interest and taxes (EBIT) are less than the break-even level? Assume there are no taxes.

Answer 33

select the unlevered option since the expected EBIT is less than the break-even level

Question 34

Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Assume there are no taxes.

Answer 34

At the break-even point, there is no advantage to debt.

Question 35

Which one of the following makes the capital structure of a firm irrelevant?

Answer 35

homemade leverage

Question 36

M&M Proposition I with no tax supports the argument that:

Answer 36

the debt-equity ratio of a firm is completely irrelevant.

Question 37

M&M Proposition I with taxes is based on the concept that:

Answer 37

the value of a firm increases as the firm’s debt increases because of the interest tax shield.

Question 38

M&M Proposition II with taxes:

Answer 38

has the same general implications as M&M Proposition II without taxes.

Question 39

The present value of the interest tax shield is expressed as:

Answer 39

Tc × D.

Question 40

Which one of the following is a direct bankruptcy cost?

Answer 40

paying an outside accountant fees to prepare bankruptcy reports

Question 41

According to the “suitability” concept covered in the Financial Planning lecture:

Answer 41

a younger person should invest into a more “risk seeking” portfolio.

Question 42

Imagine that you are a Financial Planner. According to the “suitability” concept covered in the Personal Finance lecture, you should recommend which type of investment strategy to a young man in his 20s:

Answer 42

a “growth” strategy that invests at least 70% in equities and at the most 30% in both bonds and short-term investments.

Question 43

Tracking or recording your finances

Answer 43

is an important part of managing your finances.

Question 44

In order to achieve financial freedom, you have to do which one of the following?

Answer 44

Make sure that your passive income (for example from your investment portfolio) is greater than your expenses.

Question 45

As mentioned in the lecture on personal finances, you should allocate your after-tax income into which of the following categories?

Answer 45

needs, education, financial freedom, savings for spending, fun and entertainment, and donations.

Question 46

Credit scores:

Answer 46

are an important way for a lender to estimate what your “creditworthiness” is.

Question 47

Credit scores are determined by:

Answer 47

your payment history and the amount of debt you owe.

Question 48

Advantages of credit cards include all of the following, EXCEPT:

Answer 48

We tend to spend more when using credit cards as opposed to cash.