Reference no: EM131665
XYZ common currently sells for $3/share. You believe that one-month hence the stock could be worth $8 or could be worthless. The two outcomes and probabilities are as follows:
Probability Price/shr (one-month hence)
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0.5 $8
0.5 0
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1. What is the expected price/share one-month hence?
a. $4
b. 5
c. 6
d. 7
e. 8
2. What is your expected profit per share one-month hence:
a. $40
b. 80
c. 90
d. 1.00
e. 1.20
3. What is your expected rate of return over the one-month holding period?
a. 33.33%
b. 10%
c. 25%
d. 50%
e. 4%
4. What is the probability that you will lose your entire investment in one month?
a. zero
b. 10%
c. 15%
d. 40%
e. 50%
5. Suppose that instead of investing in a single stock such as XYZ, you diversify and invest in an equally weighted portfolio of 10 different stocks. The risk of your diversified portfolio will be identical to that of the undiversified portfolio, only if the returns of the 10 stocks are:
- uncorrelated
- perfectly positively correlated
- perfectly negatively correlated
- positively correlated but not perfectly so
- negatively correlated but not perfectly so.
6. Again, suppose that instead of investing in a single stock such as XYZ, you diversify and invest in an equally weighted portfolio of 10 different stocks. Assume that each stock has an initial price of $3/share and outcomes as shown in Table 1. What is the probability that you will lose your entire investment if the returns among the 10 stocks are uncorrelated with each other?
a. 0.5
b. 0.01
c. 0.001
d. 0.00098
e. 1.0
7. (T/F) The risk assessment in the previous question ignores the effect of market risk.
8. What is your expected rate of return on the 10-stock portfolio?
a. 33.33%
b. 10%
c. 25%
d. 50%
e. 4%
9. In this case, what did you achieve by diversifying?
a. greater return and lower risk
b. greater return and same risk
c. same return and lower risk
d. greater return and greater risk
e. nothing.
10. (T/F) If Bill invests all of his money in ABC common, he bears only unsystematic risk.
11. (T/F) If Mary invests in ABC common, and in 400 other stocks, for all practical purposes she bears only systematic risk.
12. (T/F) The standard deviation of a security's returns is a measure of total risk.
13. (T/F) Total risk consists of company-specific risk plus market risk.
14. (T/F) Another term for market risk is systematic risk.
15. What is the following portfolio's beta?
Stock Amount Beta
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ABC $2,000 0.9
MMM $4,000 1.2
BBC $2,000 1.4
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a. 1.0
b. 0.95
c. 1.11
d. 1.175
e. 1.25
16. (T/F) The above portfolio is likely to do better than the market if stock prices increase, and worse than the market if stock prices decrease.
17. (T/F) The CAPM tells us that any person who seeks a large expected return must be willing to assume proportionately greater market risk.
18. (T/F) All systematic risk is diversifiable.
19 . XXX preferred stock pays an annual dividend of $4.00. How much would you pay for the stock if you require a rate of return of 8 percent?
a. $50
b. 42
c. 66
d. 80
20. MNC just paid a dividend of $2.00 on its common. How much should the stock sell for, if dividends are expected to grow forever at an annual rate of 6 percent, and if the required rate of return on the stock is 12 percent?
a. $54
b. 32.15
c. 54.5
d. 35.33
e. 25.7
21. (T/F) If the above stock is currently selling for $42/share, you would consider it overpriced.
22. You bought a stock for $20/shr., and sold it one year later for $24 after collecting a $1 dividend. What rate of return did you earn?
a. 25%
b. 33%
c.16%
d. 5%
e. 50%.
One of your clients would like to raise capital according to the following capital structure: 25% debt, 10% preferred, and 65% common. Moreover, the firm in this industry is in the 21.4% tax bracket.
23. What is the before-tax cost of debt if it issues 10-year, 6% annual coupon bonds at par, and if the flotation cost is $36 per bond?
a. 7.1%
b. 6.5
c. 7.45
d. 6.7
e. 6.0.
24. What is the after-tax cost of debt?
a. 6.72%
b. 6.01
c. 5.11
d. 5.31
e. 4.36.
25. What is the cost of preferred stock if it is sold for $50/share, it pays a dividend of $4, and the flotation cost is $6?
a. 8.89%
b. 9.09
c. 8.44
d. 8.60
e. 8.13
26. What is the cost of common stock if: the most recent dividend was $3; and dividends are expected to grow indefinitely at an 8% annual rate; the stock is sold for $55 per share, and if the flotation cost is $5 per share?
a. 15.2%
b. 14.48
c. 13.22
d. 13.44
e. 14.11.
27. The firm's weighted average cost of capital is:
a. 12.0%
b. 12.32
c. 10.53
d. 11.60
e. 11.48
28. Which of the following loans carries the highest before-tax cost of debt: (A) borrow $1,000 and pay $1,089 in one year, (B) borrow $10,000 and pay $11,236 in two years; (C) borrow $5,000 and pay $6,078 in four years?
a. A
b. B
c. C
29. (T/F) The cost of debt from the borrower's vantage point is a discount rate.
30. (T/F) The cost of debt from the lender's vantage point is a rate of return.