Investments and Risk Management Quiz

Questions and Answers

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?

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%?

3.19%

Standard deviation measures _ risk while beta measures risk.

Total, Systematic Signup and view all the answers

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%?

34.04% Signup and view all the answers

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%?

10.59% Signup and view all the answers

Given that LSUS Corporation has high fixed costs relative to its industry, what should be expected about its beta?

to have a lower beta than its industry. Signup and view all the answers

What is the correct ordering of the average arithmetic mean return for asset classes from lowest to highest?

U.S. Treasury bills, government bonds, corporate bonds, large-company stocks. Signup and view all the answers

Which statement concerning the standard deviation is correct?

The higher the standard deviation, the higher the expected return. Signup and view all the answers

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?

$4,605 Signup and view all the answers

Under what conditions is the beta of a firm likely to be high?

high cyclical business activity and high operating leverage. Signup and view all the answers

What is the excess return earned by moving from a relatively risk-free investment to a risky investment called?

Risk premium Signup and view all the answers

Which statement related to beta is correct?

The sample size used to compute beta may be too small to yield a reliable result. Signup and view all the answers

What is the weighted average cost of capital for a firm?

discount rate which the firm should apply to all of the projects it undertakes. Signup and view all the answers

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?

$6.0 Million Signup and view all the answers

What is the value of the common stock account after a 50% stock dividend if the original common stock account value is $5,000?

$7,500 Signup and view all the answers

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?

$89,600 Signup and view all the answers

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%?

0.87 Signup and view all the answers

Which example best exemplifies 'milking the property'?

A firm with high financial distress paying additional dividends. Signup and view all the answers

What is an argument in favor of a low dividend policy for LSUS Corporation?

The tax on capital gains is deferred until the gain is realized. Signup and view all the answers

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?

$35 Signup and view all the answers

The date before which a new purchaser of stock is entitled to receive a declared dividend is called the _____ date.

ex-dividend Signup and view all the answers

A payment made by the LSUS Corporation to its owners in the form of new shares of stock is called a _____ dividend.

stock Signup and view all the answers

What does MM Proposition I with no tax support?

It is completely irrelevant how a firm arranges its finances. Signup and view all the answers

What is one of the indirect costs of bankruptcy related to managers taking large risks?

Stockholders expropriate value from bondholders by selecting high-risk projects. Signup and view all the answers

What does the free cash flow hypothesis state?

That issuing debt requires interest and principal payments to be paid thereby reducing the potential of management to waste resources. Signup and view all the answers

If you own 300 shares of ABC stock and receive a 5 percent stock dividend, how many shares will you own after the dividend?

315 Signup and view all the answers

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?

$7,500 Signup and view all the answers

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.