FM- Quiz_III

1. Coefficient of Variation measures the risk per unit of expected return and is arrived
by dividing the standard deviation of return by expected return.
a. True
b. False
(Ans: A)

2. Portfolio Return is simply a weighted average return of the individual assets that
comprise the portfolio.
a. True
b. False
(Ans: A)

3. If the returns of assets in a portfolio are perfectly positively correlated (+1), then the
diversification will lead to _____________
a. Reduction in the unique risk.
b. Reduction in market risk.
c. Change in the risk and the portfolio risk will be the weighted average risk.
d. NOTA
(Ans: C)

4. A rational investor would prefer which of the two assets?

Asset Expected Return Standard Deviation

A 17% 12%
B 11% 6%

a. Asset A
b. Asset B
c. A rational investor would be indifferent
d. NOTA
(Ans: B)

5. Which of the following events would classify as an example of systematic risk?

a. Change in the management of a company
b. Ban on a product of a particular company
c. Raising the REPO rates by the Central Bank
d. NOTA
(Ans: C)

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6. __________ refers to the compensation required by the investors for a shift from
risk-free asset to risky security.
a. Market equilibrium
b. Beta
c. Equity risk premium
d. NOTA
(Ans: C)

7. Which of the following event would classify as an example of Unsystematic Risk?

a. Devaluation of the currency
b. Increase in Inflation
c. Recession in the home country
d. Labour unrest
(Ans: D)

8. The slope of the characteristics line that describes the relationship between an
individual security’s returns and returns on the market portfolio is ___________
a. Sharpe Ratio
b. Standard Deviation
c. Security Beta
d. Indifference Curve
(Ans: C)

9. According to the capital-asset pricing model (CAPM), a security's expected

(required) return is equal to the risk-free rate plus a premium ___________
a. Equal to the security’s beta.
b. Based on the unsystematic risk of security.
c. Based on the total risk of the security.
d. Based on the systematic risk of the security.
(Ans: D)

10. The risk-free security has a beta equal to _________ , while the market portfolio's
beta is equal to __________ .
a. One, more than one
b. One, less than one
c. Zero, one.
d. Less than zero, more than zero
(Ans: C)

11. The greater the beta, the _________ of the security.

a. Greater the undiversifiable risk
b. Greater the diversifiable risk
c. Less the undiversifiable risk
d. Less the diversifiable risk (Ans: A)

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12. A statistical measure of the degree to which returns of two variables move together.
a. Coefficient of variation
b. Variance
c. Covariance
d. Certainty equivalent
(Ans: C)

13. __________ type of risk is avoidable through proper diversification.

a. Portfolio risk
b. Systematic risk
c. Unsystematic risk
d. Total risk
(Ans: C)

14. In the Capital Asset Pricing Model, investors assume that buying and selling activity
will ________
a. Affect stock prices
b. Not affect stock prices
c. High transaction cost
d. NOTA
(Ans: B)

15. The advantages of debt financing include lower cost, interest tax-shield and
flexibility.
a. True
b. False
(Ans: A)

16. The Net Operating Income Approach to Capital Structure assumes that:
a. The cost of debt and equity remain constant at all degrees of leverage.
b. The overall cost of capital remains constant at all degrees of leverage.
c. The dividends per share grow at all degrees of leverage.
d. NOTA.
(Ans: B)

17. The Net Income approach to Capital Structure assumes that:

e. The cost of debt and equity remain constant at all degrees of leverage.
f. The overall cost of capital remains constant at all degrees of leverage.
g. The dividends per share grow at all degrees of leverage.
h. NOTA.
(Ans: A)

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18. According to the traditional capital structure theory, beyond a debt level the overall
cost of capital increases as the debt ________
a. Increases
b. Decreases
c. Remains the same
d. NOTA
(Ans: A)

19. According to the traditional theory of capital structure, the overall cost of capital
might decrease to a low level as the firm ________ debt financing in proportion to
equity.
a. Increases
b. Decreases
c. NOTA
(Ans: A)

20. Which of the following approaches to the capital structure do Modigliani – Miller
advocate?
a. The traditional approach
b. The net income approach
c. The net operating income approach
d. All of the above.
(Ans: C)

21. According to the Pecking Order theory, managers are likely to follow the following
priority order of financing sources:
a. Debt, Retained earnings and equity
b. Retained Earnings, debt and Equity
c. Equity, Debt and Retained Earnings
d. All sources in equal proportions
(Ans: B)

22. The term capital structure refers to how a firm has financed its business operations
by only using debt and preference share financing.
a. True
b. False
(Ans: B)

23. The levered firms are riskier compared to the unlevered firms; hence, the levered
beta would be _________ than unlevered beta.
a. Lower
b. Greater
c. Same
d. NOTA (Ans: B)

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24. The implicit costs of debt financing include the costs of possible financial distress
and agency costs.
a. True
b. False
(Ans: A)

25. The MM theory implies that there is no optimal capital structure.

a. True
b. False
(Ans: A)

26. A critical assumption of the Net Operating Income (NOI) approach to valuation is
that __________ .
a. Debt and equity levels remain unchanged.
b. Dividends increase at a constant rate.
c. Cost of Debt remains constant at all levels of debt/equity ratio.
d. Interest expense and taxes are included in the calculation.
(Ans: C)

27. The cost of monitoring the management of a firm is called ____________ .

a. Bankruptcy cost.
b. Transaction cost.
c. Agency cost.
d. Institutional cost.
(Ans: C)

28. Arbitrage means selling the same stocks at two different prices in two different
markets.
a. True
b. False
(Ans: A)

29. Net Income Approach assumes that the market value is based on its earning capacity
and is not affected by the changing debt/equity ratio.
a. True
b. False
(Ans: B)

30. __________ means that the management has more information about the future
profitability and risk of the firm than outside investors.
a. Signalling Theory
b. Agency Theory
c. Information asymmetry
d. NOTA (Ans: C)

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 31. A firm’s current capital structure comprises 20% debt and 80% equity capital. The
tax rate applicable to the firm is 30%. If the firm’s stock beta is 1.30, what would be
the unlevered beta of the firm?
a. 1.307
b. 1.175
c. 1.106
d. 1.206
(Ans: C)

Solution: 𝑩𝑼 = 𝑩𝑳 / [1 + (1 – t) (D/E)]
= 1.30 / [ 1 + (1 – 0.30) (20/80)]
= 1.30 / [ 1 + 0.7 * 0.25]
= 1.30 / [1 + 0.175]
= 1.30 / 1.175
= 1.106

32. A firm’s current capital structure comprises 20% debt and 80% equity capital. The
tax rate applicable to the firm is 30%. If the firm’s current beta is 1.25, what would
be the unlevered beta of the firm?
a. 1.307
b. 1.064
c. 1.106
d. 1.206
(Ans: B)

Solution: 𝑩𝑼 = 𝑩𝑳 / [1 + (1 – t) (D/E)]
= 1.25 / [ 1 + (1 – 0.30) (20/80)]
= 1.25 / [ 1 + 0.7 * 0.25]
= 1.25 / [1 + 0.175]
= 1.25/ 1.175
= 1.064

33. Homemade leverage is a perfect substitute for corporate leverage.

a. True
b. False
(Ans: B)

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 34. As per the MM Theory, the change in Capital Structure does not affect the firm value.
a. True
b. False
(Ans: A)

WCM

35. Net Working Capital is equal to ___________

a. Total assets
b. Fixed assets
c. Current assets
d. Current assets minus current liabilities
(Ans: D)

36. _______________ refers to the amount invested in various components of current

assets.
a. Temporary working capital
b. Net Working Capital
c. Gross working capital
d. Permanent working capital
(Ans: C)

37. ____________ is the length of time between the firm’s actual cash expenditure
(payment to suppliers) and its cash receipt from consumers.
a. Cash conversion cycle
b. Working capital cycle
c. Gross operating cycle
d. NOTA
(Ans: A)

38. _______________ refers to the length of time allowed by a firm for its customers to
make payment for their purchases.
a. Holding period
b. Days Sales Outstanding
c. Inventory days
d. Payable days
(Ans: B)

39. The current ratio indicates a firm’s capacity to comfortably meet obligations related
to its current liabilities using its current assets.
a. True
b. False
(Ans: A)

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40. A very high current ratio indicates unnecessary blocking of investment in Working
Capital.
a. True
b. False
(Ans: A)

41. The ________ inventory system emphasises that as far as possible, materials should
be purchased in-time to minimise inventory storage costs.
a. ABC Inventory control system
b. Just in Time (JIT)
c. Economic Order Quantity (EOQ)
d. NOTA
(Ans: B)

42. ________ is the order size (material per order) that minimises the total costs (annual
carrying and ordering costs).
a. ABC Inventory control system
b. Just in Time (JIT)
c. Economic Order Quantity (EOQ)
d. NOTA
(Ans: C)

43. Which of the following would be consistent with an aggressive approach to finance
working capital?
a. Financing short-term needs with short-term funds.
b. Financing permanent inventory buildup with short-term borrowings
c. Financing seasonal needs with short-term funds.
d. Financing some long-term needs with long-term funds.
(Ans: B)

44. Which of the following illustrates the matching approach of financing working
capital requirements?
a. Short-term current assets financed with long-term liabilities
b. Permanent working capital financed with long-term liabilities
c. Short-term assets financed with equity.
d. Current assets are financed with a mix of debt and equity
(Ans: B)

45. Which of the following is not included in the cost of inventory?

a. Purchase cost
b. Transportation cost
c. Import Duty
d. Promotion and advertisement costs
(Ans: D)

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46. There is no “Negative Working Capital” in a firm.
a. True
b. False
(Ans: B)

47. Under the Conservative approach, a firm opts long-term borrowings for the working
capital financing needs.
a. True
b. False
(Ans: A)

48. Under the Aggressive Approach, a firm depends more on the short-term funds to
meet working capital needs.
a. True
b. False
(Ans: A)