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Questions and Answers
Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk.
Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk.
Systematic
What indicates that a combination of two risky securities produces no diversification benefit?
What indicates that a combination of two risky securities produces no diversification benefit?
The returns on the two securities move perfectly in sync with one another.
What is the geometric average return given the returns: 12%, 6%, 13%, -11%, and -2%?
What is the geometric average return given the returns: 12%, 6%, 13%, -11%, and -2%?
3.19%
Standard deviation measures _____ risk while beta measures ____ risk.
Standard deviation measures _____ risk while beta measures ____ risk.
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What is the portfolio weight of Stock A if Stock A has an expected return of 17.8% and Stock B has an expected return of 8.4%?
What is the portfolio weight of Stock A if Stock A has an expected return of 17.8% and Stock B has an expected return of 8.4%?
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What is the amount of the risk premium on LSUS Corporation's stock with a beta of 1.23, risk-free rate of 2.86%, and market rate of return of 11.47%?
What is the amount of the risk premium on LSUS Corporation's stock with a beta of 1.23, risk-free rate of 2.86%, and market rate of return of 11.47%?
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Given that LSUS Corporation has high fixed costs relative to its industry, what should be expected about its beta?
Given that LSUS Corporation has high fixed costs relative to its industry, what should be expected about its beta?
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What is the correct ordering of the average arithmetic mean return for asset classes from lowest to highest?
What is the correct ordering of the average arithmetic mean return for asset classes from lowest to highest?
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Which statement concerning the standard deviation is correct?
Which statement concerning the standard deviation is correct?
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What is Han's total dollar return on his investment if he sold 500 shares for $58.14 each after buying them for $49.03 each and receiving a dividend of $0.10 per share?
What is Han's total dollar return on his investment if he sold 500 shares for $58.14 each after buying them for $49.03 each and receiving a dividend of $0.10 per share?
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Under what conditions is the beta of a firm likely to be high?
Under what conditions is the beta of a firm likely to be high?
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What is the excess return earned by moving from a relatively risk-free investment to a risky investment called?
What is the excess return earned by moving from a relatively risk-free investment to a risky investment called?
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Which statement related to beta is correct?
Which statement related to beta is correct?
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What is the weighted average cost of capital for a firm?
What is the weighted average cost of capital for a firm?
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If you own 25% of LSUS Corporation and the firm borrows $1.5 million to buy your shares, what is the total value of the firm today?
If you own 25% of LSUS Corporation and the firm borrows $1.5 million to buy your shares, what is the total value of the firm today?
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What is the value of the common stock account after a 50% stock dividend if the original common stock account value is $5,000?
What is the value of the common stock account after a 50% stock dividend if the original common stock account value is $5,000?
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What is the total market value of a firm with $89,600 market value and 6,500 shares outstanding after a 1-for-2 reverse stock split?
What is the total market value of a firm with $89,600 market value and 6,500 shares outstanding after a 1-for-2 reverse stock split?
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What is the debt-equity ratio for LSUS Corporation with a levered cost of equity of 14.29% and a pretax cost of debt of 7.23%?
What is the debt-equity ratio for LSUS Corporation with a levered cost of equity of 14.29% and a pretax cost of debt of 7.23%?
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Which example best exemplifies 'milking the property'?
Which example best exemplifies 'milking the property'?
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What is an argument in favor of a low dividend policy for LSUS Corporation?
What is an argument in favor of a low dividend policy for LSUS Corporation?
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What is the value of the firm to shareholders if LSUS Corporation is valued at $300 in a boom and $160 otherwise, owing $200 to debt holders?
What is the value of the firm to shareholders if LSUS Corporation is valued at $300 in a boom and $160 otherwise, owing $200 to debt holders?
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The date before which a new purchaser of stock is entitled to receive a declared dividend is called the _____ date.
The date before which a new purchaser of stock is entitled to receive a declared dividend is called the _____ date.
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A payment made by the LSUS Corporation to its owners in the form of new shares of stock is called a _____ dividend.
A payment made by the LSUS Corporation to its owners in the form of new shares of stock is called a _____ dividend.
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What does MM Proposition I with no tax support?
What does MM Proposition I with no tax support?
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What is one of the indirect costs of bankruptcy related to managers taking large risks?
What is one of the indirect costs of bankruptcy related to managers taking large risks?
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What does the free cash flow hypothesis state?
What does the free cash flow hypothesis state?
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If you own 300 shares of ABC stock and receive a 5 percent stock dividend, how many shares will you own after the dividend?
If you own 300 shares of ABC stock and receive a 5 percent stock dividend, how many shares will you own after the dividend?
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What is the value of the common stock account after a 50% stock dividend if Samuel's firm has a common stock account value of $5,000?
What is the value of the common stock account after a 50% stock dividend if Samuel's firm has a common stock account value of $5,000?
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Study Notes
Risk and Returns
- Risk that impacts multiple assets disproportionately is known as systematic risk.
- A portfolio with two securities producing no diversification benefits means the returns are perfectly correlated.
Investment Performance
- The geometric average return for a stock with varying returns (12%, 6%, 13%, -11%, -2%) over five years is 3.19%.
- Total return on a stock investment can be calculated using the formula: (Selling Price - Purchase Price) * Number of Shares + (Dividend * Number of Shares), resulting in $4,605 for 500 shares purchased at $49.03 and sold at $58.14 with a dividend of $.10/share.
Risk Metrics
- Standard deviation measures total risk, while beta assesses systematic risk.
- A higher standard deviation correlates with higher expected returns, indicating that more volatile investments typically offer greater potential rewards.
Portfolio Composition
- The expected return of a portfolio with Stocks A (17.8%) and B (8.4%) yielding an overall return of 11.6% gives Stock A a portfolio weight of 34.04%.
- Factoring fixed costs, LSUS Corporation is expected to have a lower beta than its industry average.
Market Insights
- Historical capital market returns follow this pattern from lowest to highest: U.S. Treasury bills, government bonds, corporate bonds, large-company stocks.
Cost of Capital
- The weighted average cost of capital (WACC) is the discount rate for a firm's projects.
- A firm’s debt-equity ratio can be determined through MM Proposition II, given its levered cost of equity, cost of debt, and required return on assets.
Shareholder Value
- Selling shares when a firm value is derived from a "boom" scenario reveals a potential shareholder value of $35, given the debt burden.
- A firm with a market-to-book ratio of 2.1 can see significant changes in value with stock dividends, as seen with a result of $7,500 after a 50% stock dividend.
Corporate Policies
- High financial distress yielding additional dividends is often referred to as milking the property.
- A low dividend policy is favorable due to the deferral of capital gains tax until realized.
Bankruptcy Impacts
- Indirect costs of bankruptcy include managerial incentives driving riskier projects, allowing stockholders to leverage higher rewards by expropriating value from bondholders.
Stock Dividends
- A stock dividend means a payment in the form of additional shares, which does not increase total wealth but increases the number of shares owned.
- After a 5% stock dividend on 300 shares, ownership expands to 315 shares without wealth increase.
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Description
Test your knowledge on systematic risk, investment performance, and portfolio composition with our comprehensive quiz. Explore topics such as the geometric average return and risk metrics to enhance your understanding of finance fundamentals.
