Question 1

Which of the following statements is false?

Accepted Answer

A)  Because very little trading is required to maintain it, an equal-weighted portfolio is called a passive portfolio. 
B)  If the number of shares in a value-weighted portfolio does not change, but only the prices change, the portfolio will remain value-weighted. 
C)  The CAPM says that individual investors should hold the market portfolio, a value-weighted portfolio of all risky securities in the market. 
D)  A price-weighted portfolio holds an equal number of shares of each stock, independent of their size. 
A)  Because very little trading is required to maintain it, an equal-weighted portfolio is called a passive portfolio. 
B)  If the number of shares in a value-weighted portfolio does not change, but only the prices change, the portfolio will remain value-weighted. 
C)  The CAPM says that individual investors should hold the market portfolio, a value-weighted portfolio of all risky securities in the market. 
D)  A price-weighted portfolio holds an equal number of shares of each stock, independent of their size. A

Question 2

Suppose that California Gold Mining's expected return is 2%.Then California Gold Mining's alpha is closest to:

Accepted Answer

A)  -3% 
B)  -13% 
C)  7% 
D)  -11% 
A)  -3% 
B)  -13% 
C)  7% 
D)  -11% C

Question 3

Use the table for the question(s) below.
Consider the following three individuals' portfolios consisting of investments in four stocks:
  
-The beta on Peter's portfolio is closest to:

Accepted Answer

A)  0.7 
B)  0.8 
C)  1.8 
D)  1.0 
A)  0.7 
B)  0.8 
C)  1.8 
D)  1.0 A

Question 4

Which of the following statements is false?

Accepted Answer

A)  To improve the performance of their portfolios, investors who are holding the market portfolio will compare the expected return of each security with its required return from the security market line. 
B)  The Sharpe ratio of a portfolio will increase if we sell stocks with positive alphas. 
C)  When a stock's alpha is not zero, investors can improve upon the performance of the market portfolio. 
D)  When the market portfolio is efficient, all stocks are on the security market line and have an alpha of zero. 
A)  To improve the performance of their portfolios, investors who are holding the market portfolio will compare the expected return of each security with its required return from the security market line. 
B)  The Sharpe ratio of a portfolio will increase if we sell stocks with positive alphas. 
C)  When a stock's alpha is not zero, investors can improve upon the performance of the market portfolio. 
D)  When the market portfolio is efficient, all stocks are on the security market line and have an alpha of zero.

Question 5

The cost of capital is the best expected return available in the market on investments with ________ risk.

Accepted Answer

A)  similar 
B)  bigger 
C)  smaller 
D)  different 
A)  similar 
B)  bigger 
C)  smaller 
D)  different

Question 6

Which of the following statements is false?

Accepted Answer

A)  When an investor chooses her optimal portfolio, she will do so by finding the tangent line using the risk-free rate that corresponds to her investment horizon. 
B)  If the market portfolio is not efficient, savvy investors who recognize that the market portfolio is not optimal will push prices and expected returns back into balance. 
C)  Even though different investors may research different stocks, their information will not impact the market portfolio since there is no way to share this information with other investors. 
D)  In the real world borrowers pay higher interest rates than savers receive. 
A)  When an investor chooses her optimal portfolio, she will do so by finding the tangent line using the risk-free rate that corresponds to her investment horizon. 
B)  If the market portfolio is not efficient, savvy investors who recognize that the market portfolio is not optimal will push prices and expected returns back into balance. 
C)  Even though different investors may research different stocks, their information will not impact the market portfolio since there is no way to share this information with other investors. 
D)  In the real world borrowers pay higher interest rates than savers receive.

Question 7

Which of the following statements is false?

Accepted Answer

A)  The market portfolio contains more of the smallest stocks and less of the larger stocks. 
B)  For the market portfolio, the investment in each security is proportional to its market capitalization. 
C)  Because the market portfolio is defined as the total supply of securities, the proportions should correspond exactly to the proportion of the total market that each security represents. 
D)  Market capitalization is the total market value of the outstanding shares of a firm. 
A)  The market portfolio contains more of the smallest stocks and less of the larger stocks. 
B)  For the market portfolio, the investment in each security is proportional to its market capitalization. 
C)  Because the market portfolio is defined as the total supply of securities, the proportions should correspond exactly to the proportion of the total market that each security represents. 
D)  Market capitalization is the total market value of the outstanding shares of a firm.

Question 8

Use the table for the question(s) below.
Consider the following three individuals' portfolios consisting of investments in four stocks:
  
-Assuming that the risk-free rate is 4% and the expected return on the market is 12%,then required return on Paul's portfolio is closest to:

Accepted Answer

A)  20% 
B)  22% 
C)  18% 
D)  16% 
A)  20% 
B)  22% 
C)  18% 
D)  16%

Question 9

In practice which market index is most widely used as a proxy for the Canada market portfolio in the CAPM?

Accepted Answer

A)  Dow Jones Industrial Average 
B)  Wilshire 5000 
C)  S&P/TSX Composite Index 
D)  Canadian Treasury Bill 
A)  Dow Jones Industrial Average 
B)  Wilshire 5000 
C)  S&P/TSX Composite Index 
D)  Canadian Treasury Bill

Question 10

Which of the following statements is false?

Accepted Answer

A)  All investors should demand the same efficient portfolio of securities in the same proportions. 
B)  The Capital Asset Pricing Model (CAPM) allows corporate executives to identify the efficient portfolio (of risky assets) by using knowledge of the expected return of each security. 
C)  If investors hold the efficient portfolio, then the cost of capital for any investment project is equal to its required return calculated using its beta with the efficient portfolio. 
D)  The CAPM identifies the market portfolio as the efficient portfolio. 
A)  All investors should demand the same efficient portfolio of securities in the same proportions. 
B)  The Capital Asset Pricing Model (CAPM) allows corporate executives to identify the efficient portfolio (of risky assets) by using knowledge of the expected return of each security. 
C)  If investors hold the efficient portfolio, then the cost of capital for any investment project is equal to its required return calculated using its beta with the efficient portfolio. 
D)  The CAPM identifies the market portfolio as the efficient portfolio.

Question 11

Assume that you have $100,000 to invest and you are interested in creating a value-weighted portfolio of these four stocks.The percentage of the shares outstanding of Boeing that you would hold in your portfolio is closest to:

Accepted Answer

A)  0.000018% 
B)  0.000020% 
C)  0.000024% 
D)  0.000031% 
A)  0.000018% 
B)  0.000020% 
C)  0.000024% 
D)  0.000031%

Question 12

The ________ cost of debt to the firm can be ________ once the tax deductibility of interest payments is considered.

Accepted Answer

A)  equivalent; lower 
B)  equivalent; effective 
C)  effective; higher 
D)  effective; lower 
A)  equivalent; lower 
B)  equivalent; effective 
C)  effective; higher 
D)  effective; lower

Question 13

Use the information for the question(s) below.
The Aardvark Corporation is considering launching a new product and is trying to determine an appropriate discount rate for evaluating this new product. Aardvark has identified the following information for three single division firms that offer products similar to the one Aardvark is interested in launching:
  
-The unlevered cost of capital for Antelope Incorporated is closest to:

Accepted Answer

A)  10.3% 
B)  9.9% 
C)  10.1% 
D)  9.5% 
A)  10.3% 
B)  9.9% 
C)  10.1% 
D)  9.5%

Question 14

Which of the following statements is false?

Accepted Answer

A)  The CAPM states that we should use the risk-free interest rate corresponding to the investment horizon of the firm's investors. 
B)  To determine the risk premium for a stock using the security market line, we need an estimate of the market risk premium. 
C)  When surveyed, the vast majority of large firms and financial analysts reported using the yields of Treasury Bills to determine the risk-free rate. 
D)  The risk-free interest rate is generally determined using the yields of Canadian Treasury securities, which are free from default risk. 
A)  The CAPM states that we should use the risk-free interest rate corresponding to the investment horizon of the firm's investors. 
B)  To determine the risk premium for a stock using the security market line, we need an estimate of the market risk premium. 
C)  When surveyed, the vast majority of large firms and financial analysts reported using the yields of Treasury Bills to determine the risk-free rate. 
D)  The risk-free interest rate is generally determined using the yields of Canadian Treasury securities, which are free from default risk.

Question 15

Which of the following statements is false?

Accepted Answer

A)  There is a need to calculate the cost of capital for the project's cash flows if a project's risk and leverage differ from those for the firm overall. 
B)  There is no need to calculate the cost of capital for the project's cash flows if a project's risk and leverage are the same as those for the firm overall. 
C)  There is no need to calculate the cost of capital for the project's cash flows if a project's risk and leverage differ from those for the firm overall. 
D)  None of the above. 
A)  There is a need to calculate the cost of capital for the project's cash flows if a project's risk and leverage differ from those for the firm overall. 
B)  There is no need to calculate the cost of capital for the project's cash flows if a project's risk and leverage are the same as those for the firm overall. 
C)  There is no need to calculate the cost of capital for the project's cash flows if a project's risk and leverage differ from those for the firm overall. 
D)  None of the above.

Question 16

Which of the following statements is false?

Accepted Answer

A)  Many practitioners analyze other financial characteristics of a firm when they forecast betas. 
B)  Canadian Treasuries are never subject to interest rate risk. 
C)  If a firm were to change industries, using its historical beta would be inferior to using the beta of other firms in the new industry. 
D)  When using historical returns to forecast future betas, we must be mindful of changes in the environment that might cause the future to differ from the past. 
A)  Many practitioners analyze other financial characteristics of a firm when they forecast betas. 
B)  Canadian Treasuries are never subject to interest rate risk. 
C)  If a firm were to change industries, using its historical beta would be inferior to using the beta of other firms in the new industry. 
D)  When using historical returns to forecast future betas, we must be mindful of changes in the environment that might cause the future to differ from the past.

Question 17

Luther Industries is considering borrowing $500 million to fund a new product line.Given investors' uncertainty regarding its prospects,Luther will pay a 7% interest rate on this loan.The firm's management knows that the actual risk of the loan is extremely low and that the appropriate rate on the loan is 5%.Suppose the loan is for four years,with all principal being repaid in the fourth year.If Luther's marginal corporate tax rate is 35%,then the net effect of the loan on the value of the new product line is closest to:

Accepted Answer

A)  $22 million 
B)  $34 million 
C)  $35 million 
D)  $23 million 
A)  $22 million 
B)  $34 million 
C)  $35 million 
D)  $23 million

Question 18

Which of the following statements is false?

Accepted Answer

A)  Sometimes management may believe that the securities they are issuing are priced at less than (or more than) their true value. If so, the NPV of the transaction, which is the difference between the actual money raised and the true value of the securities sold, should not be included in the value of the project. 
B)  An alternative method of incorporating financial distress and agency costs is to first value the project ignoring these costs, and then value the incremental cash flows associated with financial distress and agency problems separately. 
C)  When the debt level-and therefore the probability of financial distress-is high, the expected free cash flow will be reduced by the expected costs associated with financial distress and agency problems. 
D)  If the financing of the project involves an equity issue, and if management believes that the equity will sell at a price that is less than its true value, this mispricing is a cost of the project for the existing shareholders. 
A)  Sometimes management may believe that the securities they are issuing are priced at less than (or more than) their true value. If so, the NPV of the transaction, which is the difference between the actual money raised and the true value of the securities sold, should not be included in the value of the project. 
B)  An alternative method of incorporating financial distress and agency costs is to first value the project ignoring these costs, and then value the incremental cash flows associated with financial distress and agency problems separately. 
C)  When the debt level-and therefore the probability of financial distress-is high, the expected free cash flow will be reduced by the expected costs associated with financial distress and agency problems. 
D)  If the financing of the project involves an equity issue, and if management believes that the equity will sell at a price that is less than its true value, this mispricing is a cost of the project for the existing shareholders.

Question 19

You currently own $100,000 worth of Wal-Mart stock.Suppose that Wal-Mart has an expected return of 14% and a volatility of 23%.The market portfolio has an expected return of 12% and a volatility of 16%.The risk-free rate is 5%.Assuming the CAPM assumptions hold,what alternative investment has the lowest possible volatility while having the same expected return as Wal-Mart? What is the volatility of this portfolio?

Accepted Answer

E[R_xCML] = r_f + x(E[R_Mkt] - r_f) .14 = .

Question 20

Which of the following statements is false?

Accepted Answer

A)  With perfect capital markets, all securities are fairly priced and issuing securities is a zero-NPV transaction. 
B)  The fees associated with the financing of the project are independent of the project's required cash flows and should be ignored when calculating the NPV of the project. 
C)  When a firm borrows funds, a mispricing scenario arises if the interest rate charged differs from the rate that is appropriate given the actual risk of the loan. 
D)  The WACC, APV, and FTE methods determine the value of an investment incorporating the tax shields associated with leverage. 
A)  With perfect capital markets, all securities are fairly priced and issuing securities is a zero-NPV transaction. 
B)  The fees associated with the financing of the project are independent of the project's required cash flows and should be ignored when calculating the NPV of the project. 
C)  When a firm borrows funds, a mispricing scenario arises if the interest rate charged differs from the rate that is appropriate given the actual risk of the loan. 
D)  The WACC, APV, and FTE methods determine the value of an investment incorporating the tax shields associated with leverage.

Exam 12: Estimating the Cost of Capital

Which of the following statements is false?

Suppose that California Gold Mining's expected return is 2%.Then California Gold Mining's alpha is closest to:

Use the table for the question(s) below. Consider the following three individuals' portfolios consisting of investments in four stocks: -The beta on Peter's portfolio is closest to:

Which of the following statements is false?

The cost of capital is the best expected return available in the market on investments with ________ risk.

Which of the following statements is false?

Which of the following statements is false?

Use the table for the question(s) below. Consider the following three individuals' portfolios consisting of investments in four stocks: -Assuming that the risk-free rate is 4% and the expected return on the market is 12%,then required return on Paul's portfolio is closest to:

In practice which market index is most widely used as a proxy for the Canada market portfolio in the CAPM?

Which of the following statements is false?

Assume that you have $100,000 to invest and you are interested in creating a value-weighted portfolio of these four stocks.The percentage of the shares outstanding of Boeing that you would hold in your portfolio is closest to:

The ________ cost of debt to the firm can be ________ once the tax deductibility of interest payments is considered.

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements is false?

The Corporation

Introduction to Financial Statement Analysis

Arbitrage and Financial Decision Making

The Time Value of Money

Interest Rates

Valuing Bonds

Valuing Stocks

Investment Decision Rules

Fundamentals of Capital Budgeting

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Investor Behaviour and Capital Market Efficiency

Financial Options

Option Valuation

Real Options

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress, managerial Incentives, and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modelling: a Case Study

The Mechanics of Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

The cost of debt to the firm can be once the tax deductibility of interest payments is considered.