Test bank corporate finance 8e ros chap012

a set of returns that lie within one standard deviation of an expected rate of return b.. the frequency distribution of the average squared excess return over the risk-free rate... small

Multiple Choice Questions

1 The excess return required from a risky asset over that required from a risk-free asset is called the:

a positive square root of an average rate of return

b average squared difference between the actual return and the average return

C positive square root of a variance

d average return divided by N minus one, where N is the number of returns

e the square of the variance

SECTION: 12.4

TOPIC: STANDARD DEVIATION

TYPE: DEFINITIONS

4 What is a normal distribution?

a a set of returns that lie within one standard deviation of an expected rate of return

b a set of variances computed over a period of time by comparing actual returns to the expected rate of return

C a symmetrical frequency distribution which is defined by its mean and standard deviation

d the square root of the average squared difference between an actual return and an expected return

e the frequency distribution of the average squared excess return over the risk-free rate

7 An efficient capital market defined as a market in which:

a trading is free for all participants

b taxes are irrelevant

c investors earn a zero profit

d investors earn a profit on a security equal to the current yield

E security prices reflect available information.

A efficient market hypothesis.

b zero profit hypothesis

c open markets theorem

dividend income Given these definitions, which one of the following is the correct formula for the total return on an equity security?

10 Which one of the following correctly describes the dividend yield?

A next year's annual dividend divided by today's stock price

b this year's annual dividend divided by today's stock price

c this year's annual dividend divided by next year's expected stock price

d the annual dividend amount divided by the face value of the stock

e the increase in next year's dividend over this year's dividend divided by the current stock price

a was unaffected by the announcement

B increased proportionately with the dividend increase.

c increased by $0.06 per share

d decreased by $0.06 per share

e increased by $0.06 (1 + Dividend yield)

SECTION: 12.1

TOPIC: DIVIDEND YIELD

TYPE: CONCEPTS

I the ending, or sale, price of a security

II the average price of a security over a stated period of time

III any dividend income received

IV the beginning value, or cost, of a security

a I and III only

b II and IV only

C I and IV only

d I, III, and IV only

e I, II, III, and IV

SECTION: 12.1

TOPIC: CAPITAL GAIN

TYPE: CONCEPTS

13 The total return on a security is based on the:

a arithmetic average change in the price of the security

b average of the arithmetic and geometric average changes in the price of the security

c dividend yield

d capital gains yield

E both the dividend yield and the capital gains yield.

SECTION: 12.1

TOPIC: TOTAL RETURN

TYPE: CONCEPTS

14 The real rate of return on a stock is approximately equal to the nominal rate of return:

a multiplied by (1 + Inflation rate)

b plus the inflation rate

C minus the inflation rate.

d divided by (1 + Inflation rate)

e divided by (1 Inflation rate)

16 Small-company stocks, as the term is used in the textbook, are defined as the common stock of:

a the 500 newest corporations in the U.S

b all the firms whose stock trades OTC

C the smallest twenty percent of the firms listed on the NYSE.

d the smallest twenty-five percent of the firms listed on NASDAQ

e all the firms whose stock is listed on NASDAQ

a U.S Treasury bills

b large company stocks

C small company stocks

d long-term corporate bonds

e long-term government bonds

SECTION: 12.3

TOPIC: HISTORICAL RECORD

TYPE: CONCEPTS

18 Which one of the following categories of securities had the lowest average risk premium for the period 1926 – 2005?

a long-term government bonds

b small company stocks

c large company stocks

d long-term corporate bonds

E U.S Treasury bills

SECTION: 12.2

TOPIC: RISK PREMIUM

TYPE: CONCEPTS

19 On average, for the period 1926 – 2005:

a the real rate of return on U.S Treasury bills has been negative

b small company stocks have underperformed large company stocks

c long-term government bonds have earned a higher real rate of return than have long-term corporate bonds

D the risk premium on U.S Treasury bills has been zero percent.

e the risk premium on large company stocks has exceeded the risk premium on small

c intermediate-term government bonds

d U.S Treasury bills

E small-company stocks

SECTION: 12.4

TOPIC: STANDARD DEVIATION

TYPE: CONCEPTS

21 Over the period 1926 – 2005, the annual rate of inflation:

a was always positive

b was only negative during the Great Depression

c never exceeded ten percent

D fluctuated significantly from one year to the next.

e tended to be negative during the years of World War II

SECTION: 12.2

TOPIC: HISTORICAL RECORD

TYPE: CONCEPTS

22 Which one of the following time periods is associated with high rates of inflation?

a The annual rate of return always exceeded the annual inflation rate

b The average risk premium was 1.1 percent

c The annual rate of return was always positive

D The average excess return was 1.1 percent.

e The average real rate of return was equal to zero

a large company stocks, U.S Treasury bills, long-term government bonds

b small company stocks, long-term corporate bonds, large company stocks

C small company stocks, long-term government bonds, long-term corporate bonds

d large company stocks, long-term corporate bonds, long-term government bonds

e long-term government bonds, long-term corporate bonds, U.S Treasury bills

SECTION: 12.4

TOPIC: STANDARD DEVIATION

TYPE: CONCEPTS

25 What was the highest annual rate of inflation during the period 1926 – 2005?

26 The excess return is computed as the:

a return on a security minus the inflation rate

B return on a risky security minus the risk-free rate.

c risk premium on a risky security minus the risk-free rate

d the risk-free rate plus the inflation rate

e risk-free rate minus the inflation rate

a long-term corporate bonds

b U.S Treasury bills

28 Over the period of 1926 – 2005, the average rate of inflation was _ percent

31 What was the average risk premium on U.S Treasury bills over the period 1926 – 2005?

32 Which one of the following is a correct statement concerning risk premium?

A The greater the volatility of returns, the greater the risk premium.

b The lower the volatility of returns, the greater the risk premium

c The lower the average rate of return, the greater the risk premium

d The risk premium is not correlated to the average rate of return

e The risk premium is not affected by the volatility of returns

34 To convince investors to accept greater volatility in the annual rate of return on an investment, you must:

a decrease the risk premium

B increase the risk premium.

c decrease the real return

d decrease the risk-free rate

e increase the risk-free rate

36 The larger the variance, the:

I more the actual returns differ from the average return

II larger the standard deviation

III greater the risk

IV higher the expected return

a I and III only

b II, III, and IV only

c I, III, and IV only

d I, II, and III only

E I, II, III, and IV

SECTION: 12.4

TOPIC: VARIANCE

TYPE: CONCEPTS

37 The variance of a series of returns on a security is computed by dividing the sum of the:

A squared deviations by the number of returns minus one.

b average returns by the number of returns minus one

c average returns by the number of returns plus one

d squared deviations by the average rate of return

e squared deviations by the number of returns plus one

SECTION: 12.4

TOPIC: VARIANCE

TYPE: CONCEPTS

38 Which of the following statements concerning the standard deviation are correct?

I The greater the standard deviation, the lower the risk

II The standard deviation is a measure of volatility

III The higher the standard deviation, the less certain the rate of return in any one given year

IV The higher the standard deviation, the higher the expected return

a I and III only

B II, III, and IV only

c I, III, and IV only

d I, II, and III only

e I, II, III, and IV

SECTION: 12.4

TOPIC: STANDARD DEVIATION

TYPE: CONCEPTS

39 The standard deviation of the returns on small-company stocks for the period 1926 – 2005indicates that:

a there is minimal variation in the rate of return from one year to the next year

B small-company stocks are more volatile than large-company stocks.

c stocks are generally less volatile than corporate bonds

d the variance of those returns is approximately double the variance of a risk-free security

e the frequency of those returns produces a relatively narrow bell curve

SECTION: 12.4

TOPIC: STANDARD DEVIATION

TYPE: CONCEPTS

40 Which of the following statements are true?

I Risk and potential reward are inversely related

II There is a reward for bearing risk

III Without risk, an investment would earn the U.S Treasury bill rate

IV The greater the potential reward, the higher the risk

a I and II only

b III and IV only

c II and IV only

D II, III, and IV only

e I, II, III, and IV

42 The primary purpose of Blume's formula is to:

a compute an accurate historical rate of return

b determine a stock's true current value

c consider compounding when estimating a rate of return

d determine the actual real rate of return

E project future rates of return.

SECTION: 12.6

TOPIC: BLUME'S FORMULA

TYPE: CONCEPTS

43 In an efficient market, the price of a security will:

a always rise immediately upon the release of new information with no further price

adjustments related to that information

b react to new information over a two-day period after which time no further price

adjustments related to that information will occur

c rise sharply when new information is first released and then decline to a new stable level bythe following day

D react immediately to new information with no further price adjustments related to that

44 Which one of the following is indicative of a totally efficient stock market?

a extraordinary returns earned on a routine basis

b positive net present values over the long-term

C zero net present values for all stocks

d arbitrage opportunities which develop on a routine basis

e realizing negative returns on a routine basis

SECTION: 12.6

TOPIC: MARKET EFFICIENCY

TYPE: CONCEPTS

45 Which one of the following statements is correct concerning market efficiency?

a Real asset markets are more efficient than financial markets

b If a market is efficient, arbitrage opportunities should be common

c In an efficient market, some market participants will have an advantage over others

D A firm will generally receive a fair price when it sells shares of stock.

e New information will gradually be reflected in a stock's price to avoid any sudden change

in the price of the stock

SECTION: 12.6

TOPIC: MARKET EFFICIENCY

TYPE: CONCEPTS

46 Financial markets fluctuate daily because:

a the markets are inefficient

B the markets are continually reacting to new information.

c arbitrage trading occurs daily

d every day adds more information to the historical record

e traders are unsure of the actual value of any security

SECTION: 12.6

TOPIC: MARKET EFFICIENCY

TYPE: CONCEPTS

47 Trading on inside information does not offer any advantages if the financial markets are:

a weak form efficient

b semiweak form efficient

c semistrong form efficient

D strong form efficient.

a is effective as long as the market is only semistrong form efficient

b is effective provided the market is only weak form efficient

C is ineffective even when the market is only weak form efficient.

d becomes ineffective as soon as the market gains semistrong form efficiency

e is ineffective only in strong form efficient markets

SECTION: 12.6

TOPIC: MARKET EFFICIENCY

TYPE: CONCEPTS

49 Which of the following statements related to market efficiency tend to be supported by current evidence?

I markets tend to respond quickly to new information

II investors can easily earn excess profits

III short-run prices are difficult to predict accurately based on public information

IV markets are most likely only weak form efficient

A I and III only

b II and IV only

c I and IV only

d I, III, and IV only

e I, II, and III only

51 Your best friend works in the finance office of Capital Leasing You are aware that this friend trades stocks based on information he overhears in the office You know that this information is not known to the general public Your friend continually brags to you about theprofits he earns on these trades Based on this information, you would tend to argue that the financial markets are at best _ form efficient

53 Individuals who continually monitor the financial markets seeking mispriced securities:

a earn excess profits over the long-term

B make the markets increasingly more efficient.

c are never able to find a security that is temporarily mispriced

d are overwhelmingly successful provided they trade within five minutes of their discovery

e are always quite successful using only historical price information as their basis of evaluation

SECTION: 12.6

TOPIC: MARKET EFFICIENCY

TYPE: CONCEPTS

54 One year ago, you purchased a stock at a price of $28.75 The stock pays quarterly

dividends of $.35 per share Today, the stock is worth $31.25 per share What is the total amount of your capital gains to date from this investment?

56 A year ago, you purchased 200 shares of Holland Enterprises, Inc stock at a price of

$15.54 per share The stock pays an annual dividend of $.20 per share Today, you sold all of your shares for $17.70 per share What is your total dollar return on this investment?

Total dollar return = ($17.70 $15.54 + $.20) 200 = $472

AACSB TOPIC: ANALYTIC

Dividend per share = $336 / 300 = $1.12; Dividend yield = $1.12 / $35.86 = 3.1 percent

AACSB TOPIC: ANALYTIC

SECTION: 12.1

TOPIC: DIVIDEND YIELD

TYPE: PROBLEMS

58 Bankers, Inc stock is currently selling for $80 a share The stock has a dividend yield of 4.2 percent How much dividend income will you receive per year if you purchase 150 shares

60 You just sold 400 shares of Bosley, Inc stock at a price of $49.60 a share Last year you paid $50.50 a share to buy this stock Over the course of the year, you received dividends totaling $1.96 per share What is your capital gain on this investment?

Capital gain = ($49.60 $50.50) 400 = $360 (capital loss)

AACSB TOPIC: ANALYTIC

Cost = 200 $38.12 = $7,624; Capital gains yield = ($8,130 $7,624) / $7,624 = 6.6 percent

AACSB TOPIC: ANALYTIC

SECTION: 12.1

TOPIC: CAPITAL GAIN

TYPE: PROBLEMS

62 Today, you sold 100 shares of Natural, Inc stock Your total return on these shares is 10.5percent You purchased the shares one year ago at a price of $25.75 a share You have

received a total of $110 in dividends over the course of the year What is your capital gains yield on this investment?

Total dollar return = ($14.20 $12.70 + $.05) 1,300 = $2,015

AACSB TOPIC: ANALYTIC

SECTION: 12.1

TOPIC: TOTAL RETURN

TYPE: PROBLEMS