Questions and Answers
Which one of the following had the smallest risk premium for the period of 1926-2006?
Over the period 1926-2006, small company stocks earned an average rate of return of _____ percent.
Which one of the following forms of market efficiency would best prevent any individual from benefitting from insider trading?
When receiving the historical record as presented in the textbook, long term bonds are defined as bonds with _____ years to maturity.
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Over the period of 1926-2006, U.S. Treasury Bills had a rate of return that was _____ than the average rate of inflation and had a standard deviation that was _____ the standard deviation of inflation.
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Which one of these statements is true as of 2006?
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An efficient market generally implies that
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The weights assigned to individual securities in a portfolio when computing the portfolio rate of return are:
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Which of the following is an example of systematic risk?
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Standard deviation measures _____ risk while beta measures ______ risk.
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Which one of the following is classified as erosion?
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Which of the following should be included in the analysis of a project?
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The operating cash flow of a tax paying firm that has a positive net income will:
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All else equal, ignoring the option to abandon will most likely cause the NPV of a project to be:
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Which of the following is the primary determinant of the cost of capital for a project?
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National Energy has 3 divisions. If the divisions could not be given separate betas, management believes that division A's beta would be 5 percent higher than division B's and 15 percent lower than division C's. What will happen to the risk level of National Energy over time if the firm uses its WACC as the required return for all its projects?
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Which one of the following is an opportunity cost?
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Which one of the following is most apt to occur only at the end of a project?
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Which one of the following will most likely increase the NPV of a project?
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Study Notes
Historical Risk Premiums
- Long-term government bonds had the smallest risk premium from 1926-2006.
- Small company stocks generated the highest average return of 17.4% during the same period.
Market Efficiency
- Strong form market efficiency prevents any individual from profiting from insider trading, ensuring all information is reflected in stock prices.
- Efficient markets imply securities are fairly priced based on available information.
Bonds and Maturity
- Long-term bonds are categorized as having 20 years to maturity.
- U.S. Treasury Bills provided higher returns than average inflation while having lower standard deviation risks compared to inflation.
Stock Market Changes
- The largest single-day percentage drop in the DJIA occurred in 1987, marking significant market volatility.
Portfolio Management
- The weights assigned in a portfolio are based on the current market value of each security, not equal or initial amounts invested.
Risk Analysis
- Systematic risk is exemplified by wide-reaching political actions, such as Congress raising corporate tax rates.
- Standard deviation measures total risk, while beta indicates systematic risk.
Project Analysis
- Erosion impact is observed when the introduction of new products reduces sales of existing items, such as a burger shop selling fewer burgers after adding barbecue sandwiches.
- Opportunity costs should be included in project analysis, while sunk costs should not.
Operating Cash Flow
- A firm's operating cash flow will increase if depreciation expenses rise, benefiting tax calculations.
Net Present Value (NPV) Considerations
- Ignoring the option to abandon a project can lead to an underestimated NPV.
- The determination of a project's cost of capital is largely shaped by the use of that project’s funds.
Risk Management in Divisions
- As National Energy uses its WACC across all projects without separate betas for its divisions, overall risk is expected to increase over time.
Opportunity Costs
- Utilizing unused equipment for new projects represents an opportunity cost, affecting potential valuation.
Project Completion Aspects
- Salvage value of equipment becomes relevant primarily at the end of a project, differentiating it from ongoing operating cash flows.
NPV Influencers
- Increasing depreciation expenses can positively influence the NPV of projects by optimizing tax-related cash flow.
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Description
This quiz covers key finance concepts such as historical risk premiums, market efficiency, and portfolio management strategies. It also delves into the characteristics of bonds, stock market changes, and risk analysis techniques. Test your understanding of these vital finance topics!
