Midterm 2 Flashcards - Quizlet

3/2/2018 Financial Management Midterm Flashcards | Quizlet
Financial Management Midterm 81 terms kate072911
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B One of the four most fundamental factors

that affect the cost of money as discussed
in the text is the expected rate of inflation.
If inflation is expected to be relatively high,
https://quizlet.com/29134100/ﬁnancial-management-midterm-ﬂash-cards/ 1/42
then interest rates will tend to be relatively

low, other things held constant.
A. True
B. false
A If the demand curve for funds increased

but the supply curve remained constant,
we would expect to see the total amount
of funds supplied and demanded increase
and interest rates in general also increase.
A. True
B. false
A During the periods when inflation is

increasing, interest rates tend to increase,
while interest rates tend to fall when
inflation is declining.
A. True
B. false
A If investors expect a zero rate of inflation ,

then nominal rate of return on a very short-
term U.S. Treasury bond should be equal to
the real risk-free rate, r*.
A. True
B. false
A If investors expect the rate of inflation to

increase sharply in the future, then we
should not be surprised to see an upward
sloping yield curve.
A. True
B. false
A The "yield curve" shows the relationship

between bonds maturities and their yields.
A. True
B. false
B Because the maturity risk premium is

normally positive, the yield curve must
have an upward slope. If you measure the
yield curve and find a downward slope,
you must have done something wrong.
A. True
B. false
B If the treasury yield curve were downward

sloping, the yield to maturity on a 10- year
treasury coupon bond would be higher
than that on a 1-year T-bill.
A. True
B. false
A An upward-sloping yield curve is often

called a "normal" yield curve, while a
downward-sloping yield curve is called
"abnormal".
A. True
B. false
A The federal reserve tends to take actions to

increase rates when the economy is very
strong and to decrease rates when the
economy is weak.
A. True
B. False
A Assume the inflation is expected to decline

steadily on the future, but that the real risk-
free rate, r*, will remain constant. Which
one I the following statements is correct,
other things held constant?
A. If the pure expectations theory holds,

the treasury yield curve must be a
downward sloping.
B. If the pure expectations theory holds,
the corporate yield curve must be a
downward sloping.
C. If there is a positive maturity risk
premium, the treasury yield curve must be

upward sloping.
D. If inflation I expected to decline, there
can be no maturity risk premium.
E. The expectations theory cannot hold if
inflation is decreasing.
C Which of the following statements is
CORRECT, other things held constant?
a. If companies have fewer good

investment opportunities, interest rates are
likely to increase.
b. If individuals increase their savings rate,
interest rates are likely to increase.
c. If expected inflation increases, interest
rates are likely to increase.
d. Interest rates on all debt securities tend
to rise during recessions because
recessions increase the possibility of
bankruptcy, hence the riskiness of all debt
securities.
e. Interest rates on long-term bonds are
more volatile than rates on short-term debt
securities like T-bills.
B Assume that interest rates on 20-year

Treasury and corporate bonds are as
follows:
T-bond = 7.72% AAA = 8.72% A = 9.64% BBB

= 10.18%
The differences in these rates were

probably caused primarily by:
a. Tax effects.
b. Default and liquidity risk differences.
c. Maturity risk differences.
d. Inflation differences.
e. Real risk-free rate differences.
A If the Treasury yield curve is downward
sloping, how should the yield to maturity
on a 10-year Treasury coupon bond
compare to that on a 1-year T-bill?
a. The yield on a 10-year bond would be

less than that on a 1-year bill.
b. The yield on a 10-year bond would have
to be higher than that on a 1year bill
because of the maturity risk premium.
c. It is impossible to tell without knowing
the coupon rates of the bonds.
d. The yields on the two securities would
be equal.
e. It is impossible to tell without knowing
the relative risks of the two securities.
B The real risk-free rate is expected to
remain constant at 3% in the future, a 2%

rate of inflation is expected for the next 2
years, after which inflation is expected to
increase to 4%, and there is a positive
maturity risk premium that increases with
years to maturity. Given these conditions,
which of the following statements is
CORRECT?
a. The yield on a 2-year T-bond must

exceed that on a 5-year T-bond.
b. The yield on a 5-year Treasury bond
must exceed that on a 2-year Treasury
bond.
c. The yield on a 7-year Treasury bond must
exceed that of a 5-year corporate bond.
d. The conditions in the problem cannot all
be true--they are internally inconsistent.
e. The Treasury yield curve under the
stated conditions would be humped rather
than have a consistent positive or negative
slope.
A Which of the following statements is
CORRECT?
a. If inflation is expected to increase in the

future, and if the maturity risk premium
(MRP) is greater than zero, then the
Treasury yield curve will have an upward
slope.
b. If the maturity risk premium (MRP) is
greater than zero, then the yield curve
must have an upward slope.
c. Because long-term bonds are riskier
than short-term bonds, yields on long-
term Treasury bonds will always be higher
than yields on short-term T-bonds.
d. If the maturity risk premium (MRP)
equals zero, the yield curve must be flat.
e. The yield curve can never be downward
sloping.
C Which of the following statements is

CORRECT?
a. The higher the maturity risk premium, the

higher the probability that the yield curve
will be inverted.
b. The most likely explanation for an
inverted yield curve is that investors expect
inflation to increase.
c. The most likely explanation for an
inflation to decrease.
d. If the yield curve is inverted, short-term
bonds have lower yields than long-term
bonds.
e. Inverted yield curves can exist for
Treasury bonds, but because of default

premiums, the corporate yield curve can
never be inverted.
c Assuming that the term structure of interest

rates is determined as posited by the pure
expectations theory, which of the following
statements is CORRECT?
a. In equilibrium, long-term rates must be

equal to short-term rates.
b. An upward-sloping yield curve implies
that future short-term rates are expected
to decline.
c. The maturity risk premium is assumed to
be zero.
d. Inflation is expected to be zero.
e. Consumer prices as measured by an
index of inflation are expected to rise at a
constant rate.
d If the pure expectations theory of the term

structure is correct, which of the following
statements would be CORRECT?
a. An upward-sloping yield curve would

imply that interest rates are expected to be
lower in the future.
b. If a 1-year Treasury bill has a yield to
maturity of 7% and a 2-year Treasury bill

has a yield to maturity of 8%, this would
imply the market believes that 1-year rates
will be 7.5% one year from now.
c. The yield on a 5-year corporate bond
should always exceed the yield on a 3-year
Treasury bond.
d. Interest rate (price) risk is higher on
long-term bonds, but reinvestment rate risk
is higher on short-term bonds.
e. Interest rate (price) risk is higher on
short-term bonds, but reinvestment rate
risk is higher on long-term bonds.
A Suppose 1-year T-bills currently yield 7.00%
and the future inflation rate is expected to
be constant at 3.20% per year. What is the
real risk-free rate of return, r*? (Disregard
any cross-product terms, i.e., if averaging is
required, use the arithmetic average).
a. 3.80%
b. 3.99%
c. 4.19%
d. 4.40%
e. 4.62%
B The real risk-free rate is 3.05%, inflation is

expected to be 2.75% this year, and the
maturity risk premium is zero. Ignoring any
cross-product terms, what is the

equilibrium rate of return on a 1-year
Treasury bond?
a. 5.51%
b. 5.80%
c. 6.09%
d. 6.39%
e. 6.71%
d Suppose the real risk-free rate is 4.20%, the
average expected future inflation rate is
3.10%, and a maturity risk premium of 0.10%
per year to maturity applies, i.e., MRP =
0.10%(t), where t is the years to maturity,
hence the pure expectations theory is NOT
valid. What rate of return would you
expect on a 4-year Treasury security?
Disregard cross-product terms, i.e., if
averaging is required, use the arithmetic
average.
a. 6.60%
b. 6.95%
c. 7.32%
d. 7.70%
e. 8.09%
d The real risk-free rate is 3.55%, inflation is

expected to be 3.15% this year, and the
maturity risk premium is zero. Taking

account of the cross-product term, i.e., not
ignoring it, what is the equilibrium rate of
return on a 1-year Treasury bond?
a. 5.840%
b. 6.148%
c. 6.471%
d. 6.812%
e. 7.152%
c Suppose the yield on a 10-year T-bond is
currently 5.05% and that on a 10-year
Treasury Inflation Protected Security (TIPS)
is 2.15%. Suppose further that the MRP on a
10-year T-bond is 0.90%, that no MRP is
required on a TIPS, and that no liquidity
premium is required on any Tbond. Given
this information, what is the expected rate
of inflation over the next 10 years?
Disregard cross-product terms, i.e., if
averaging is required, use the arithmetic
average.
a. 1.81%
b. 1.90%
c. 2.00%
d. 2.10%
e. 2.21%
b Suppose 10-year T-bonds have a yield of

5.30% and 10-year corporate bonds yield
6.75%. Also, corporate bonds have a 0.25%
liquidity premium versus a zero liquidity
premium for T-bonds, and the maturity risk
premium on both Treasury and corporate
10-year bonds is 1.15%. What is the default
risk premium on corporate bonds?
a. 1.08%
b. 1.20%
c. 1.32%
d. 1.45%
e. 1.60%
b Koy Corporation's 5-year bonds yield

7.00%, and 5-year T-bonds yield 5.15%. The
real risk-free rate is r* = 3.0%, the inflation
premium for 5-year bonds is IP = 1.75%, the
liquidity premium for Koy's bonds is LP =
0.75% versus zero for T-bonds, and the
maturity risk premium for all bonds is found
with the formula MRP = (t - 1) × 0.1%, where t
= number of years to maturity. What is the
default risk premium (DRP) on Koy's
bonds?
a. 5.94%
b. 6.60%
c. 7.26%
d. 7.99%
e. 8.78%
d Kay Corporation's 5-year bonds yield

6.20% and 5-year T-bonds yield 4.40%. The
real risk-free rate is r* = 2.5%, the inflation
premium for 5-year bonds is IP = 1.50%, the
default risk premium for Kay's bonds is DRP
= 1.30% versus zero for T-bonds, and the
maturity risk premium for all bonds is found
with the formula MRP = (t - 1) × 0.1%, where t
= number of years to maturity. What is the
liquidity premium (LP) on Kay's bonds?
a. 0.36%
b. 0.41%
c. 0.45%
d. 0.50%
e. 0.55%
a Kern Corporation's 5-year bonds yield

7.30% and 5-year T-bonds yield 4.10%. The
real risk-free rate is r* = 2.5%, the default
risk premium for Kern's bonds is DRP =
1.90% versus zero for T-bonds, the liquidity
premium on Kern's bonds is LP = 1.3%, and
the maturity risk premium for all bonds is
found with the formula MRP = (t - 1) × 0.1%,
where t = number of years to maturity.
What is the inflation premium (IP) on all 5-

year bonds?
a. 1.20%
b. 1.32%
c. 1.45%
d. 1.60%
e. 1.68%
c Kelly Inc's 5-year bonds yield 7.50% and 5-

year T-bonds yield 4.90%. The real risk-free
rate is r* = 2.5%, the default risk premium
for Kelly's bonds is DRP = 0.40%, the
liquidity premium on Kelly's bonds is LP =
2.2% versus zero on T-bonds, and the
inflation premium (IP) is 1.5%. What is the
maturity risk premium (MRP) on all 5-year
bonds?
a. 0.73%
b. 0.81%
c. 0.90%
d. 0.99%
e. 1.09%
e Kop Corporation's 5-year bonds yield

6.50%, and T-bonds with the same maturity
yield 4.40%. The default risk premium for
Kop's bonds is DRP = 0.40%, the liquidity
premium on Kop's bonds is LP = 1.70%
versus zero on T-bonds, the inflation

premium (IP) is 1.50%, and the maturity risk
premium (MRP) on 5-year bonds is 0.40%.
What is the real risk-free rate, r*?
a. 2.04%
b. 2.14%
c. 2.26%
d. 2.38%
e. 2.50%
c Suppose the real risk-free rate is 3.50% and

the future rate of inflation is expected to
be constant at 2.20%. What rate of return
would you expect on a 1-year Treasury
security, assuming the pure expectations
theory is valid?
a. 5.21%
b. 5.49%
c. 5.78%
d. 6.07%
e. 6.37%
b Suppose the real risk-free rate is 3.00%, the

average expected future inflation rate is
2.25%, and a maturity risk premium of 0.10%
per year to maturity applies, i.e., MRP =
0.10%(t), where t is the years to maturity.
What rate of return would you expect on a
1-year Treasury security, assuming the pure

expectations theory is NOT valid? Include
the cross-product term, i.e., if averaging is
required, use the geometric average.
a. 5.15%
b. 5.42%
c. 5.69%
d. 5.97%
e. 6.27%
e Suppose the interest rate on a 1-year T-

bond is 5.0% and that on a 2year T-bond is
7.0%. Assuming the pure expectations
theory is correct, what is the market's
forecast for 1-year rates 1 year from now?
a. 7.36%
b. 7.75%
c. 8.16%
d. 8.59%
e. 9.04%
a Suppose the real risk-free rate is 3.25%, the

average future inflation rate is 4.35%, and a
maturity risk premium of 0.07% per year to
maturity applies to both corporate and T-
bonds, i.e., MRP = 0.07%(t), where t is the
years to maturity. Suppose also that a
liquidity premium of 0.50% and a default
risk premium of 0.90% apply to A-rated

corporate bonds but not to T-bonds. How
much higher would the rate of return be on
a 10-year A-rated corporate bond than on
a 5-year Treasury bond?
a. 1.75%
b. 1.84%
c. 1.93%
d. 2.03%
e. 2.13%
b The tighter the probability distribution of its

expected future returns, the greater the
risk of a given investment as measured by
its standard deviation.
a. True
b. False
b The standard deviation is a better measure

of risk than the coefficient of variation if the
expected returns of the securities being
compared differ significantly.
a. True
b. False
a When adding a randomly chosen new

stock to an existing portfolio, the higher (or
more positive) the degree of correlation

between the new stock and stocks already
in the portfolio, the less the additional
stock will reduce the portfolio's risk.
a. True
b. False
a When adding a randomly chosen new

stock to an existing portfolio, the higher (or
more positive) the degree of correlation
between the new stock and stocks already
in the portfolio, the less the additional
stock will reduce the portfolio's risk.
a. True
b. False
b The realized return on a stock portfolio is

the weighted average of the expected
returns on the stocks in the portfolio.
a. True
b. False
a Market risk refers to the tendency of a

stock to move with the general stock
market. A stock with above-average market
risk will tend to be more volatile than an
average stock, and its beta will be greater
than 1.0.
a. True
b. False
a According to the Capital Asset Pricing

Model, investors are primarily concerned
with portfolio risk, not the risks of
individual stocks held in isolation. Thus, the
relevant risk of a stock is the stock's
contribution to the riskiness of a well-
diversified portfolio.
a. True
b. False
a Variance is a measure of the variability of

returns, and since it involves squaring the
deviation of each actual return from the
expected return, it is always larger than its
square root, the standard deviation.
a. True
b. False
a Because of differences in the expected

returns on different investments, the
standard deviation is not always an
adequate measure of risk. However, the
coefficient of variation adjusts for
differences in expected returns and thus

allows investors to make better
comparisons of investments' stand-alone
risk.
a. True
b. False
a "Risk aversion" implies that investors require

higher expected returns on riskier than on
less risky securities.
a. True
b. False
b A stock's beta is more relevant as a

measure of risk to an investor who holds
only one stock than to an investor who
holds a well-diversified portfolio.
a. True
b. False
b A portfolio's risk is measured by the

weighted average of the standard
deviations of the securities in the portfolio.
It is this aspect of portfolios that allows
investors to combine stocks and thus
reduce the riskiness of their portfolios.
a. True
b. False
a Bad managerial judgments or unforeseen

negative events that happen to a firm are
defined as "company-specific," or
"unsystematic," events, and their effects on
investment risk can in theory be diversified
away.
a. True
b. False
b The CAPM is built on historic conditions,

although in most cases we use expected
future data in applying it. Because betas
used in the CAPM are calculated using
expected future data, they are not subject
to changes in future volatility. This is one of
the strengths of the CAPM.
a. True
b. False
a The slope of the SML is determined by

investors' aversion to risk. The greater the
average investor's risk aversion, the steeper
the SML.
a. True
b. False
a Since the market return represents the

expected return on an average stock, the
market return reflects a certain amount of
risk. As a result, there exists a market risk
premium, which is the amount over and
above the risk-free rate, that is required to
compensate stock investors for assuming
an average amount of risk.
a. True
b. False
c You have the following data on three

stocks:
Stock Standard Deviation Beta

A 20% 0.59
B 10% 0.61
C 12% 1.29
If you are a strict risk minimizer, you would

choose Stock ____ if it is to be held in
isolation and Stock ____ if it is to be held as
part of a well-diversified portfolio.
a. A; A.
b. A; B.
c. B; A.
d. C; A.
e. C; B.
c A highly risk-averse investor is considering

adding one additional stock to a 3-stock
portfolio, to form a 4-stock portfolio. The
three stocks currently held all have b = 1.0,
and they are perfectly positively correlated
with the market. Potential new Stocks A
and B both have expected returns of 15%,
are in equilibrium, and are equally
correlated with the market, with r = 0.75.
However, Stock A's standard deviation of
returns is 12% versus 8% for Stock B. Which
stock should this investor add to his or her
portfolio, or does the choice not matter?
a. Either A or B, i.e., the investor should be

indifferent between the two.
b. Stock A.
c. Stock B.
d. Neither A nor B, as neither has a return
sufficient to compensate for risk.
e. Add A, since its beta must be lower.
c Which of the following statements is

CORRECT?
a. The beta of a portfolio of stocks is

always smaller than the betas of any of the
individual stocks.
b. If you found a stock with a zero historical
beta and held it as the only stock in your
portfolio, you would by definition have a
riskless portfolio.
c. The beta coefficient of a stock is
normally found by regressing past returns
on a stock against past market returns. One
could also construct a scatter diagram of
returns on the stock versus those on the
market, estimate the slope of the line of
best fit, and use it as beta. However, this
historical beta may differ from the beta that
exists in the future.
d. The beta of a portfolio of stocks is
always larger than the betas of any of the
individual stocks.
e. It is theoretically possible for a stock to
have a beta of 1.0. If a stock did have a beta
of 1.0, then, at least in theory, its required
rate of return would be equal to the risk-
free (default-free) rate of return, rRF.
e Stock A's beta is 1.5 and Stock B's beta is

0.5. Which of the following statements must
be true, assuming the CAPM is correct.
a. Stock A would be a more desirable

addition to a portfolio then Stock B.
b. In equilibrium, the expected return on
Stock B will be greater than that on Stock
A.
c. When held in isolation, Stock A has more
risk than Stock B.
d. Stock B would be a more desirable
addition to a portfolio than A.
e. In equilibrium, the expected return on
Stock A will be greater than that on B.
d You have the following data on (1) the

average annual returns of the market for
the past 5 years and (2) similar information
on Stocks A and B. Which of the possible
answers best describes the historical betas
for A and B?
Years Market Stock A Stock B

1 0.03 0.16 0.05
2 -0.05 0.20 0.05
3 0.01 0.18 0.05
4 -0.10 0.25 0.05
5 0.06 0.14 0.05
a. bA > 0; bB = 1.
b. bA > +1; bB = 0.
c. bA = 0; bB = -1.
d. bA < 0; bB = 0.
e. bA < -1; bB = 1.
c Inflation, recession, and high interest rates

are economic events that are best
characterized as being
a. systematic risk factors that can be

diversified away.
b. company-specific risk factors that can
be diversified away.
c. among the factors that are responsible
for market risk.
d. risks that are beyond the control of
investors and thus should not be
considered by security analysts or
portfolio managers.
e. irrelevant except to governmental
authorities like the Federal Reserve.
b Which of the following statements is

CORRECT?
a. A large portfolio of randomly selected

stocks will always have a standard
deviation of returns that is less than the
standard deviation of a portfolio with fewer
stocks, regardless of how the stocks in the
smaller portfolio are selected.
b. Diversifiable risk can be reduced by

forming a large portfolio, but normally
even highly-diversified portfolios are
subject to market (or systematic) risk.
c. A large portfolio of randomly selected
stocks will have a standard deviation of
returns that is greater than the standard
deviation of a 1-stock portfolio if that one
stock has a beta less than 1.0.
d. A large portfolio of stocks whose betas
are greater than 1.0 will have less market
risk than a single stock with a beta = 0.8.
e. If you add enough randomly selected
stocks to a portfolio, you can completely
eliminate all of the market risk from the
portfolio.
d For a portfolio of 40 randomly selected

stocks, which of the following is most likely
to be true?
a. The riskiness of the portfolio is greater

than the riskiness of each of the stocks if
each was held in isolation.
b. The riskiness of the portfolio is the same
as the riskiness of each stock if it was held
in isolation.
c. The beta of the portfolio is less than the
weighted average of the betas of the
individual stocks.
d. The beta of the portfolio is equal to the
weighted average of the betas of the
individual stocks.
e. The beta of the portfolio is larger than
the weighted average of the betas of the
individual stocks.
c Your portfolio consists of $50,000 invested

in Stock X and $50,000 invested in Stock Y.
Both stocks have an expected return of
15%, betas of 1.6, and standard deviations
of 30%. The returns of the two stocks are
independent, so the correlation coefficient
between them, rXY, is zero. Which of the
following statements best describes the
characteristics of your 2-stock portfolio?
a. Your portfolio has a standard deviation

of 30%, and its expected return is 15%.
b. Your portfolio has a standard deviation
less than 30%, and its beta is greater than
1.6.
c. Your portfolio has a beta equal to 1.6,
and its expected return is 15%.
d. Your portfolio has a beta greater than
1.6, and its expected return is greater than
15%.
e. Your portfolio has a standard deviation

b greaterAthan
Stocks and30%
B each
andhave
a beta
an equal
expected
to 1.6.
return of 15%, a standard deviation of 20%,
and a beta of 1.2. The returns on the two
stocks have a correlation coefficient of
+0.6. You have a portfolio that consists of
50% A and 50% B. Which of the following
a. The portfolio's beta is less than 1.2.

b. The portfolio's expected return is 15%.
c. The portfolio's standard deviation is
greater than 20%.
d. The portfolio's beta is greater than 1.2.
e. The portfolio's standard deviation is 20%.
b Stock A has a beta = 0.8, while Stock B has

a beta = 1.6. Which of the following
a. Stock B's required return is double that

of Stock A's.
b. If the marginal investor becomes more
risk averse, the required return on Stock B
will increase by more than the required
return on Stock A.
c. An equally weighted portfolio of Stocks
A and B will have a beta lower than 1.2.
d. If the marginal investor becomes more
risk averse, the required return on Stock A

will increase by more than the required
return on Stock B.
e. If the risk-free rate increases but the
market risk premium remains constant, the
required return on Stock A will increase by
more than that on Stock B.
d Which of the following statements is

CORRECT? (Assume that the risk-free rate
is a constant.)
a. If the market risk premium increases by

1%, then the required return will increase
for stocks that have a beta greater than 1.0,
but it will decrease for stocks that have a
beta less than 1.0.
b. The effect of a change in the market risk
premium depends on the slope of the yield
curve.
c. If the market risk premium increases by
1%, then the required return on all stocks
will rise by 1%.
d. If the market risk premium increases by
1%, then the required return will increase
by 1% for a stock that has a beta of 1.0.
e. The effect of a change in the market risk
premium depends on the level of the risk-
free rate.
a Which of the following statements is

CORRECT?
a. The slope of the security market line is

equal to the market risk premium.
b. Lower beta stocks have higher required
returns.
c. A stock's beta indicates its diversifiable
risk.
d. Diversifiable risk cannot be completely
diversified away.
e. Two securities with the same stand-alone
risk must have the same betas.
d 64. Assume that to cool off the economy

and decrease expectations for inflation,
the Federal Reserve tightened the money
supply, causing an increase in the risk-free
rate, rRF. Investors also became concerned
that the Fed's actions would lead to a
recession, and that led to an increase in the
market risk premium, (rM - rRF). Under
these conditions, with other things held
constant, which of the following
statements is most correct?
a. The required return on all stocks would

increase by the same amount.
b. The required return on all stocks would
increase, but the increase would be

greatest for stocks with betas of less than
1.0.
c. Stocks' required returns would change,
but so would expected returns, and the
result would be no change in stocks'
prices.
d. The prices of all stocks would decline,
but the decline would be greatest for high-
beta stocks.
e. The prices of all stocks would increase,
but the increase would be greatest for
high-beta stocks.
c Taggart Inc.'s stock has a 50% chance of

producing a 25% return, a 30% chance of
producing a 10% return, and a 20% chance
of producing a -28% return. What is the
firm's expected rate of return?
a. 9.41%
b. 9.65%
c. 9.90%
d. 10.15%
e. 10.40%
a Cheng Inc. is considering a capital

budgeting project that has an expected
return of 25% and a standard deviation of
30%. What is the project's coefficient of
variation?
a. 1.20
b. 1.26
c. 1.32
d. 1.39
e. 1.46
e Bill Dukes has $100,000 invested in a 2-

stock portfolio. $35,000 is invested in
Stock X and the remainder is invested in
Stock Y. X's beta is 1.50 and Y's beta is 0.70.
What is the portfolio's beta?
a. 0.65
b. 0.72
c. 0.80
d. 0.89
e. 0.98
b Assume that you hold a well-diversified

portfolio that has an expected return of
11.0% and a beta of 1.20. You are in the
process of buying 1,000 shares of Alpha
Corp at $10 a share and adding it to your
portfolio. Alpha has an expected return of
13.0% and a beta of 1.50. The total value of
your current portfolio is $90,000. What will
the expected return and beta on the
portfolio be after the purchase of the
Alpha stock?
a. 10.64%; 1.17
b. 11.20%; 1.23
c. 11.76%; 1.29
d. 12.35%; 1.36
e. 12.97%; 1.42
d Calculate the required rate of return for

Climax Inc., assuming that (1) investors
expect a 4.0% rate of inflation in the future,
(2) the real risk-free rate is 3.0%, (3) the
market risk premium is 5.0%, (4) the firm has
a beta of 1.00, and (5) its realized rate of
return has averaged 15.0% over the last 5
years.
a. 10.29%
b. 10.83%
c. 11.40%
d. 12.00%
e. 12.60%
a Porter Inc's stock has an expected return

of 12.25%, a beta of 1.25, and is in
equilibrium. If the risk-free rate is 5.00%,
what is the market risk premium?
a. 5.80%
b. 5.95%
c. 6.09%
d. 6.25%
e. 6.40%
b Roenfeld Corp believes the following

probability distribution exists for its stock.
What is the coefficient of variation on the
company's stock?
Probability Stock's
State of of State Expected
the Economy Occurring Return
Boom 0.45 25%
Normal 0.50 15%
Recession 0.05 5%
a. 0.2839
b. 0.3069
c. 0.3299
d. 0.3547
e. 0.3813
b 72. Jim Angel holds a $200,000 portfolio

consisting of the following stocks:
Stock Investment Beta

A $ 50,000 0.95
B 50,000 0.80
C 50,000 1.00
D 50,000 1.20
Total $200,000
What is the portfolio's beta?
a. 0.938
b. 0.988
c. 1.037
d. 1.089
e. 1.143
a Which of the following statements is

CORRECT?
a. Even if the pure expectations theory is

correct, there might at times be an inverted
Treasury yield curve.
b. If the yield curve is inverted, short-term
bonds have lower yields than long-term
bonds.
c. The higher the maturity risk premium, the
higher the probability that the yield curve
will be inverted.
d. Inverted yield curves can exist for
Treasury bonds, but because of default
premiums, the corporate yield curve
cannot become inverted.
e. The most likely explanation for an
inflation to increase in the future.
e You hold a diversified $100,000 portfolio

consisting of 20 stocks with $5,000
invested in each. The portfolio's beta is 1.12.
You plan to sell a stock with b = 0.90 and
use the proceeds to buy a new stock with
b = 1.80. What will the portfolio's new beta
be?
a. 1.286
b. 1.255
c. 1.224
d. 1.194
e. 1.165
a Mikkelson Corporation's stock had a

required return of 11.75% last year, when
the risk-free rate was 5.50% and the market
risk premium was 4.75%. Then an increase
in investor risk aversion caused the market
risk premium to rise by 2%. The risk-free
rate and the firm's beta remain unchanged.
What is the company's new required rate of
return? (Hint: First calculate the beta, then
find the required return.)
a. 14.38%
b. 14.74%
c. 15.11%
d. 15.49%
d e. 15.87%
Kollo Enterprises has a beta of 1.10, the real
risk-free rate is 2.00%, investors expect a
3.00% future inflation rate, and the market
risk premium is 4.70%. What is Kollo's
required rate of return?
a. 9.43%
b. 9.67%
c. 9.92%
d. 10.17%
e. 10.42%
e Consider the following information and

then calculate the required rate of return
for the Global Investment Fund, which
holds 4 stocks. The market's required rate
of return is 13.25%, the risk-free rate is
7.00%, and the Fund's assets are as follows:
Stock Investment Beta

A $ 200,000 1.50
B 300,000 -0.50
C 500,000 1.25
D $1,000,000 0.75
a. 9.58%
b. 10.09%
c. 10.62%
d. 11.18%
e. 11.77%
a Mulherin's stock has a beta of 1.23, its
required return is 11.75%, and the risk-free
rate is 4.30%. What is the required rate of
return on the market?
a. 10.36%
b. 10.62%
c. 10.88%
d. 11.15%
e. 11.43%
c Suppose you hold a portfolio consisting of

a $10,000 investment in each of 8 different
common stocks. The portfolio's beta is 1.25.
Now suppose you decided to sell one of
your stocks that has a beta of 1.00 and to
use the proceeds to buy a replacement
stock with a beta of 1.35. What would the
portfolio's new beta be?
a. 1.17
b. 1.23
c. 1.29
d. 1.36
e. 1.43
b Carson Inc.'s manager believes that

economic conditions during the next year
will be strong, normal, or weak, and she

thinks that the firm's returns will have the
probability distribution shown below.
What's the standard deviation of the
estimated returns? (Hint: Use the formula
for the standard deviation of a population,
not a sample.)
Economic
Conditions Prob. Return
Strong 30% 32.0%
Normal 40% 10.0%
Weak 30% -16.0%
a. 17.69%
b. 18.62%
c. 19.55%
d. 20.52%
e. 21.55%
a Assume that you manage a $10.00 million

mutual fund that has a beta of 1.05 and a
9.50% required return. The risk-free rate is
4.20%. You now receive another $5.00
million, which you invest in stocks with an
average beta of 0.65. What is the required
rate of return on the new portfolio? (Hint:
You must first find the market risk premium,
then find the new portfolio beta.)
a. 8.83%
b. 9.05%
c. 9.27%
d. 9.51%
e. 9.74%

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3/2/2018 Financial Management Midterm Flashcards | Quizlet

Financial Management Midterm 81 terms kate072911

B One of the four most fundamental factors

then interest rates will tend to be relatively

A If the demand curve for funds increased

A During the periods when inflation is

A If investors expect a zero rate of inflation ,

A If investors expect the rate of inflation to

A The "yield curve" shows the relationship

B Because the maturity risk premium is

B If the treasury yield curve were downward

A An upward-sloping yield curve is often

A The federal reserve tends to take actions to

A Assume the inflation is expected to decline

A. If the pure expectations theory holds,

premium, the treasury yield curve must be

a. If companies have fewer good

B Assume that interest rates on 20-year

T-bond = 7.72% AAA = 8.72% A = 9.64% BBB

The differences in these rates were

a. The yield on a 10-year bond would be

B The real risk-free rate is expected to

remain constant at 3% in the future, a 2%

a. The yield on a 2-year T-bond must

a. If inflation is expected to increase in the

C Which of the following statements is

a. The higher the maturity risk premium, the

Treasury bonds, but because of default

c Assuming that the term structure of interest

a. In equilibrium, long-term rates must be

d If the pure expectations theory of the term

a. An upward-sloping yield curve would

maturity of 7% and a 2-year Treasury bill

B The real risk-free rate is 3.05%, inflation is

cross-product terms, what is the

d The real risk-free rate is 3.55%, inflation is

maturity risk premium is zero. Taking

b Suppose 10-year T-bonds have a yield of

b Koy Corporation's 5-year bonds yield

d Kay Corporation's 5-year bonds yield

a Kern Corporation's 5-year bonds yield

What is the inflation premium (IP) on all 5-

c Kelly Inc's 5-year bonds yield 7.50% and 5-

e Kop Corporation's 5-year bonds yield

versus zero on T-bonds, the inflation

c Suppose the real risk-free rate is 3.50% and

b Suppose the real risk-free rate is 3.00%, the

1-year Treasury security, assuming the pure

e Suppose the interest rate on a 1-year T-

a Suppose the real risk-free rate is 3.25%, the

risk premium of 0.90% apply to A-rated

b The tighter the probability distribution of its

b The standard deviation is a better measure

a When adding a randomly chosen new

more positive) the degree of correlation

a When adding a randomly chosen new

b The realized return on a stock portfolio is

a Market risk refers to the tendency of a

a According to the Capital Asset Pricing

a Variance is a measure of the variability of

a Because of differences in the expected

differences in expected returns and thus

a "Risk aversion" implies that investors require