FIN 534 – Homework Chapter 6

Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 25 points for this homework assignment.

1. You are considering investing in one of the these 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; B.

b. B; A.

c. C; A.

d. C; B.

e. A; A.

2. Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. 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. Stock A.

b. Stock B.

c. Neither A nor B, as neither has a return sufficient to compensate for risk.

d. Add A, since its beta must be lower.

e. Either A or B, i.e., the investor should be indifferent between the two.

3. Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

a. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the “true” or “expected future” beta.

b. The beta of an “average stock,” or “the market,” can change over time, sometimes drastically.

c. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.

d. All of the statements above are true.

e. The fact that a security or project may not have a past history that can be used as the basis for calculating beta.

4. Stock A’s beta is 1.7 and Stock B’s beta is 0.7. Which of the following statements must be true about these securities? (Assume market equilibrium.)

a. Stock B must be a more desirable addition to a portfolio than A.

b. Stock A must be a more desirable addition to a portfolio than B.

c. The expected return on Stock A should be greater than that on B.

d. The expected return on Stock B should be greater than that on A.

e. When held in isolation, Stock A has more risk than Stock B.

5. Which of the following statements is CORRECT?

a. 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.

b. 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.

c. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.

d. 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. The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.

`FIN 534 – Homework Chapter 7`
` `
`Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 25 points for this homework assignment.`
` `
`1. The preemptive right is important to shareholders because it`
`a. will result in higher dividends per share.`
`b. is included in every corporate charter.`
`c. protects the current shareholders against a dilution of their ownership interests.`
`d. protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.`
`e. allows managers to buy additional shares below the current market price.`
` `
`2. Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?`
`a. All common stocks, regardless of class, must have the same voting rights.`
`b. All firms have several classes of common stock.`
`c. All common stock, regardless of class, must pay the same dividend.`
`d. Some class or classes of common stock are entitled to more votes per share than other classes.`
`e. All common stocks fall into one of three classes: A, B, and C.`
` `
`3. Which of the following statements is CORRECT?`
`a. Two firms with the same expected dividend and growth rates must also have the same stock price.`
`b. It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant.`
`c. If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.`
`d. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.`
`e. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.`
` `
`4. A stock is expected to pay a year-end dividend of \$2.00, i.e., D1 = \$2.00. The dividend is expected to decline at a rate of 5% a year forever (g = ?5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?`
`a. The company's dividend yield 5 years from now is expected to be 10%.`
`b. The constant growth model cannot be used because the growth rate is negative.`
`c. The company's expected capital gains yield is 5%.`
`d. The company's expected stock price at the beginning of next year is \$9.50.`
`e. The company's current stock price is \$20.`
` `
`5. If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.`
`a. The stock's dividend yield is 5%.`
`b. The price of the stock is expected to decline in the future.`
`c. The stock's required return must be equal to or less than 5%.`
`d. The stock's price one year from now is expected to be 5% above the current price.`
`e. The expected return on the stock is 5% a year.`
`FIN 534 – Homework Chapter 8`
` `
`Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 25 points for this homework assignment.`
` `
`1. An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?`
`a. Put`
`b. Naked`
`c. Covered`
`d. Out-of-the-money`
`e. In-the-money`
` `
`2. Cazden Motors' stock is trading at \$30 a share. Call options on the company's stock are also available, some with a strike price of \$25 and some with a strike price of \$35. Both options expire in three months. Which of the following best describes the value of these options?`
`a. The options with the \$25 strike price will sell for less than the options with the \$35 strike price.`
`b. The options with the \$25 strike price have an exercise value greater than \$5.`
`c. The options with the \$35 strike price have an exercise value greater than \$0.`
`d. If Cazden's stock price rose by \$5, the exercise value of the options with the \$25 strike price would also increase by \$5.`
`e. The options with the \$25 strike price will sell for \$5.`
` `
`3. Braddock Construction Co.'s stock is trading at \$20 a share. Call options that expire in three months with a strike price of \$20 sell for \$1.50. Which of the following will occur if the stock price increases 10%, to \$22 a share?`
`a. The price of the call option will increase by more than \$2.`
`b. The price of the call option will increase by less than \$2, and the percentage increase in price will be less than 10%.`
`c. The price of the call option will increase by less than \$2, but the percentage increase in price will be more than 10%.`
`d. The price of the call option will increase by more than \$2, but the percentage increase in price will be less than 10%.`
`e. The price of the call option will increase by \$2.`
` `
`4. Which of the following statements is CORRECT?`
`a. Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.`
`b. Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.`
`c. Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.`
`d. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.`
`e. If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.`
` `
`5. Which of the following statements is CORRECT?`
`a. Call options generally sell at a price less than their exercise value.`
`b. If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.`
`c. Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.`
`d. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.`
`e. If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock's price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.`
`FIN 534 – Homework Chapter 9`
` `
` `
`Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 25 points for this homework assignment.`
` `
`1. When working with the CAPM, which of the following factors can be determined with the most precision?`
`a. The beta coefficient, bi, of a relatively safe stock.`
`b. The most appropriate risk-free rate, rRF.`
`c. The expected rate of return on the market, rM.`
`d. The beta coefficient of "the market," which is the same as the beta of an average stock.`
`e. The market risk premium (RPM).`
` `
`2. Bloom and Co. has no debt or preferred stock? it uses only equity capital, and has two equally-sized divisions. Division X's cost of capital is 10.0%, Division Y's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division X's projects are equally risky, as are all of Division Y's projects. However, the projects of Division X are less risky than those of Division Y. Which of the following projects should the firm accept?`
`a. A Division Y project with a 12% return.`
`b. A Division X project with an 11% return.`
`c. A Division X project with a 9% return.`
`d. A Division Y project with an 11% return.`
`e. A Division Y project with a 13% return.`
` `
`3. Taylor Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?`
`a. Project C, which is of above-average risk and has a return of 11%.`
`b. Project A, which is of average risk and has a return of 9%.`
`c. None of the projects should be accepted.`
`d. All of the projects should be accepted.`
`e. Project B, which is of below-average risk and has a return of 8.5%.`
` `
`4. Weatherall Enterprises has no debt or preferred stock? it is an all-equity firm?and has a beta of 2.0. The chief financial officer is evaluating a project with an expected return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than an average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT?`
`a. The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return.`
`b. Riskier-than-average projects should have their expected returns increased to reflect their higher risk. Clearly, this would make the project acceptable regardless of the amount of the adjustment.`
`c. The accept/reject decision depends on the firm's risk-adjustment policy. If Weatherall's policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project.`
`d. Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus, insufficient information has been provided to make the accept/reject decision.`
`e. The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return.`
` `
`5. The Anderson Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company's average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO's position is accepted, what is likely to happen over time?`
`a. The company will take on too many low-risk projects and reject too many high-risk projects.`
`b. Things will generally even out over time, and, therefore, the firm's risk should remain constant over time.`
`c. The company's overall WACC should decrease over time because its stock price should be increasing.`
`d. The CEO's recommendation would maximize the firm's intrinsic value.`
`e. The company will take on too many high-risk projects and reject too many low-risk projects.`

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