See the correct answers in BOLD.

1. Use the following information to answer the question below.

If the market risk premium is 6% and the risk-free rate is 4%, then the expected return of
investing in International Business Machines is closest to:
● 4.38%
● 8.38%
● 5.46%
● 9.4%
Response Feedback: Return = .04 + 0.73(.06) = .0838

2. Suppose that in the coming year, you expect ExxonMobil's stock to have a volatility of
42% and a beta of 0.9, and Merck's stock to have a volatility of 24% and a beta of 1.1.
The risk-free interest rate is 4% and the expected market return is 12%. Which stock
has the highest systematic risk?
Merck since it has a higher beta
ExxonMobil since it has a higher volatility
Merck since it has a lower volatility
ExxonMobil since it has a lower beta

Response Feedback: Systematic risk is captured by a stock's beta.

3. Consider the following price and dividend data for the General Electric Company:

The total return (including dividends and reinvested dividends) from December 31, 2018 to April
28, 2019 of an investment in the stock of the General Electric Company is closest to:
-37.57%
None of the suggested returns is close to the total return.
-35.25%
-34.84%
Response Feedback:
=(13.35+0.2)/14.64*(9.14+0.2)/13.35-1

4. Which of the following statements is FALSE?

When the market portfolio is efficient, all stocks are on the capital market line.
To improve the performance of their portfolios, investors who are holding the market portfolio will
compare the expected return of each security with its required return from the security market
line.
When a stock's alpha is not zero, investors can improve upon the performance of the market
portfolio.
The Sharpe ratio of a portfolio will increase if we sell stocks with negative alphas.

Response Feedback:
When the market portfolio is efficient, all stocks are on the security market line (not: capital
market line).

5. Assume that the Wilshire 5000 stock market index currently has a dividend yield of 2%
and that on average, the dividends of Wilshire 5000 firms have increased by about 7%
per year. If the risk-free interest rate is 4%, then your estimate for the future market risk
premium is:

8%
4%
5%
7%

Response Feedback:
r = d 1/ p 0 + g = dividend yield + g = .02 + .07 = .09
Risk premium = expected return on market - risk free rate = .09 - .04 = .05

6. Consider the following information regarding corporate bonds:

Wyatt Oil has a bond issue outstanding with seven years to maturity, and a CCC rating. The
risk-free rate is 2% and the market risk premium is 5%. Wyatt Oil's cost of debt is closest to:
4.17%
5%
2%
3.55%
Response Feedback: =rf + beta * rp market

7. Assume that Google's corporate tax rate is 30%. Also assume that Google's current
equity cost of capital is 6.6%, that Google's debt holders require a return of 4.8% (which
corresponds to Google's pre-tax cost of debt), and that Google's debt to value ratio is
0.29. Then, Google's after-tax WACC in percent (rounded to two digits) is:
5.66 ± 0.05
Response Feedback:
(1-debt to value ratio)*required return on equity + debt to value ratio * required return on debt *
(1- tax rate)

8. Select the alternative that completes the sentence correctly: "In perfect capital markets,
the overall cost of capital ..."

increases as the debt/equity ratio increases.

does not change as the debt/equity ratio increases.
decreases as the debt/equity ratio increases.
None of the suggested alternatives completes the sentence correctly.

9. A firm without debt has an asset beta of 1. Assuming that the firm is not subject to
corporate tax and a beta of debt equal to zero, what is the equity beta of the firm if the
firm takes on debt for a total of 50% of the value of its assets? (rounded to one decimal)

2
Answer range +/-
0.1 (1.9 - 2.1 )
Response Feedback:
2.0

10. What are the condition(s) under which the market portfolio might not be an efficient
portfolio?

Most investors prefer to buy and hold rather than actively trade.
Investors are extremely risk averse.
Very few investors trade.
A significant number of investors care about aspects of their portfolios other than
expected return and volatility and so are willing to hold inefficient portfolios of securities.
Investors invest significant amounts in the risk-free asset.

11. Green Sauce AG has assets with a market value of ​600 ​million EUR, ​
of which 40 million EUR are cash. It has debt of ​220 ​million EUR, and 20 million shares
outstanding. Assume perfect capital markets.
The current stock price is [a] EUR per share. (Rounded to the nearest cent)
If Green Sauce distributes 40 million EUR as a dividend, the share price after the dividend is
paid will be [b] EUR. (Rounded to the nearest cent)
After the dividend payment debt represents [c]% of the value of the assets. (Rounded to two
decimals.)

price per share: (value assets - debt)/number of shares outstanding;

price per share after dividend: price per share - payment amount / number of shares
outstanding
debt to value ratio: debt / (new price per share * number of shares outstanding + debt)

12. Do underwriters face the most risk from a​best-efforts IPO, a firm commitment​IPO, or an
auction​IPO?

One cannot tell which is the most risky because each of these three methods bears equivalent
risk.
One cannot tell which is the most risky because the risk eventually depends only on the supply
and demand conditions at the time of issue.
A firm commitment IPO.
An auction IPO.
A​best-efforts IPO.

13. Suppose you buy a European call option on Sanofi stock with the strike price of €80.00
and keep it until maturity. The price of the call is €6.27. What would be your percentage
return if the Sanofi stock price is €95 at the expiry date of the call? (in percent, Round to
one decimal place.)

139.2
Answer range +/-
0.2 (139.0 - 139.4 )
Response Feedback: payoff/(option premium) -1

14. Your investment portfolio consists of $13,000 invested in only one stock—Amazon.
Suppose the risk-free rate is 6%, Amazon stock has an expected return of 11% and a
volatility of 39%, and the market portfolio has an expected return of 10% and a volatility
of 16%.

Under the CAPM assumptions, what alternative investment has the lowest possible volatility
while having the same expected return as Amazon? What is the volatility of this investment?

To create an alternative investment that has the lowest possible volatility while having the same
expected return as Amazon, we use the following strategy:

Sell:$[13000] worth of Amazon stock. (Round to the nearest dollar.)

Borrow:$[3250] at the risk-free rate. (Round to the nearest dollar.)

Buy:$[16250] worth of the market portfolio. (Round to the nearest dollar.)

Buy:$[0] worth of the risk-free investment. (Round to the nearest dollar.)

This portfolio has a volatility of [20.0]% (Round to one decimal place.)

15. Jaegermeister SE has announced a ​dividend of 2.7 EUR per share.

If​its last​cum-dividend share price is ​60 EUR​, what should its first​ex-dividend price be​
(assuming perfect capital​markets)?
(In EUR and rounded to the nearest cent.)

57.30 ± 0.05
Response Feedback: cum dividend price - dividend payment

16. Suppose Intel’s stock has an expected return of 20% and a volatility of 30%, while
Coca-Cola’s has an expected return of 7% and volatility of 30%.

If these two stocks were perfectly negatively correlated (i.e., their correlation coefficient is −1),
calculate the portfolio weights that remove all risk.
1. The portfolio of these two stocks that has zero risk is [50.0] % of Coca-Cola​(Round to one
decimal place)

2. and [50.0] % of Intel. ​(Round to one decimal place)

17. Suppose you group all the stocks in the world into two mutually exclusive portfolios
(each stock is in only one portfolio): growth stocks and value stocks. Suppose the two
portfolios have equal size (in terms of total value), a correlation of 0.5, and the following
characteristics:

The risk-free rate is 3%.

Calculate the Sharpe ratios of the value​stock, growth​stock, and market portfolio.

The Sharpe ratio of the value stocks is [0.86] ​(Round to two decimal​places.) or 0.85 0.87
The Sharpe ratio of the growth stocks is [0.55] ​(Round to two decimal​places.) or 0.54 0.56
The Sharpe ratio of the market portfolio is [0.74] (Round to two decimal​places.) or 0.75 0.73

18. What are the main advantages of going public?

Increased access to capital markets is a primary advantage of going public.

Decreased exposure to sources of capital is another advantage of going public.

A very significant advantage of going public is that by doing so a firm can satisfy all of the
requirements of being a public company such as SEC filings and listing requirements of the
securities exchanges.

One advantage of going public is increased liquidity. It is easier to buy and sell the
company's shares.

19. Criteo has 32 million shares outstanding trading for $9 per share. In addition, Criteo has
$85 million in outstanding debt. Suppose Criteo’s equity cost of capital is 13%, its debt
cost of capital is 9%, and the corporate income tax rate is 32%.
What is​Criteo's after-tax debt cost of​capital?

Criteo's after-tax debt cost of capital is [6.1] % (Round to one decimal place.) 6.0-6.2

What is Criteo’s (after-tax) weighted average cost of capital?

Criteo's (after-tax) weighted average cost of capital is [11.4] %. (Round to one decimal place.)
11.3-11.5

20. Assuming perfect capital markets, Modigliani and Miller (MM) propose that the market
value and the cost of capital of any firm are independent of its capital structure. Which of
the following statements are correct?(Select all choices that apply.)
Under the assumptions of the MM propositions, capital budgeting decisions can be made
without considering the firm’s capital structure as leverage does not affect the average
cost of capital.

Under the assumptions of the MM propositions, an increase in leverage will neither affect the
firm’s average cost of capital nor its equity cost of capital.

In real capital markets, a firm can increase its market value by increasing the level of debt
as they profit from the tax shield.

With respect to real capital markets, the trade-off approach tries to maximize the market value of
the firm by optimizing the firm’s capital structure between tax advantages of debt and the
agency cost of equity.

In real capital markets, an increasing leverage ratio might reduce the firm’s market value
due to higher cost of financial distress.