Finance Applications and Theory 2Nd Edition Cornett Test Bank Full Chapter PDF

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Chapter 10 - Estimating Risk and Return
Chapter 10
Estimating Risk and Return
Multiple Choice Questions
1. Which of the following is a true statement?

A. The risk and return that a firm experienced in the past is also the risk level for its future.
B. Firms can quite possibly change their stocks' risk level by substantially changing their
business.
C. If a firm takes on riskier new projects over time, the firm itself will become less risky.
D. If a firm takes on less risky new projects over time, the firm itself will become more risky.
2. This is the average of the possible returns weighted by the likelihood of those returns
occurring.
A. efficient return
B. expected return
C. market return
D. required return
3. The set of probabilities for all possible occurrences.

A. probability
B. probability distribution
C. stock market bubble
D. market probabilities
4. This is typically considered the return on U.S. government bonds and bills and equals the
real interest plus the expected inflation premium.
A. required return
B. risk-free rate
C. risk premium
D. market risk premium
10-1
5. This is the reward investors require for taking risk.

A. required return
B. risk-free rate
C. risk premium
6. This is the reward for taking systematic stock market risk.

A. required return
B. risk-free rate
C. risk premium
7. This model includes an equation that relates a stock's required return to an appropriate risk
premium:
A. asset pricing
B. behavioral finance
C. beta
D. efficient markets
8. The asset pricing theory based on a beta, a measure of market risk.

A. Behavioral Asset Pricing Model
B. Capital Asset Pricing Model
C. Efficient Markets Asset Pricing Model
D. Efficient Market Hypothesis
9. In theory, this is a combination of securities that places the portfolio on the efficient
frontier and on a line tangent from the risk-free rate.
A. efficient market
B. market portfolio
C. probability distribution
D. stock market bubble
10-2
10. The use of debt to increase an investment position.

A. behavioral finance
B. financial leverage
C. probability
11. Which of these is the line on a graph of return and risk (standard deviation) from the risk-
free rate through the market portfolio?
A. Capital Asset Pricing Line
B. Capital Market Line
C. Efficient Market Line
12. A measure of the sensitivity of a stock or portfolio to market risk.

B. beta
C. efficient market
D. hedge
13. Similar to the Capital Market Line except risk is characterized by beta instead of standard
deviation.
A. Market Risk Line
B. Probability Market Line
C. Security Market Line
D. Stock Market Line
14. Which of these is the measurement of risk for a collection of stocks for an investor?
A. beta
B. efficient market
C. expected return
D. portfolio beta
10-3
15. Which of the following is NOT a necessary condition for an efficient market?
A. Many buyers and sellers.
B. No prohibitively high barriers to entry.
C. Free and readily available information available to all participants.
D. No trading or transaction costs.
16. The stocks of small companies that are priced below $1 per share.
A. bargain stocks
B. hedge fund stocks
C. penny stocks
D. stock market bubble stocks
17. A theory that describes the types of information that are reflected in current stock prices.
A. asset pricing
C. efficient market hypothesis
D. public information
18. This is data that includes past stock prices and volume, financial statements, corporate
news, analyst opinions, etc.
A. audited financial statements
B. generally accepted accounting principles
C. privately held information
19. This has not been released to the public, but is known by few individuals, likely company
insiders.
B. restricted stock
D. insider trading
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20. Investor enthusiasm causes an inflated bull market that drives prices too high, ending in a
dramatic collapse in prices.
A. behavior finance
B. efficient market
21. The study of the cognitive processes and biases associated with making financial and
economic decisions.
A. asset pricing model
22. Shares of stock issued to employees that have limitations on when they can be sold.
A. executive stock options
B. privately held information
C. restricted stock
23. Special rights given to some employees to buy a specific number of shares of the company
stock at a fixed price during a specific period of time.
C. restricted stock
24. The constant growth model assumes which of the following?

A. That there is privately held information.
B. That the stock is efficiently priced.
C. That there are executive stock options available to managers.
D. That there is no restricted stock.
10-5
25. Expected Return Compute the expected return given these three economic states, their
likelihoods, and the potential returns:
A. 6.8%
B. 12.8%
C. 16.0%
D. 22.7%
A. 13.5%
B. 22.5%
C. 18.3%
D. 40.0%
27. Required Return If the risk-free rate is 8 percent and the market risk premium is 2
percent, what is the required return for the market?
A. 2%
B. 6%
C. 8%
D. 10%
10-6
A. 4%
B. 7%
C. 10%
D. 14%
29. Risk Premium The annual return on the S&P 500 Index was 12.4 percent. The annual T-
bill yield during the same period was 5.7 percent. What was the market risk premium during
that year?
A. 5.7%
B. 6.7%
C. 12.4%
D. 18.1%
that year?
A. 6.2%
B. 11.9%
C. 18.1%
D. 24.3%
31. CAPM Required Return A company has a beta of 0.50. If the market return is expected
to be 12 percent and the risk-free rate is 5 percent, what is the company's required return?
A. 6.0%
B. 8.5%
C. 11.0%
D. 13.5%
10-7
to be 14 percent and the risk-free rate is 5.5 percent, what is the company's required return?
A. 22.750%
B. 33.125%
C. 45.500%
D. 51.000%
A. 33.250%
B. 39.375%
C. 48.875%
D. 55.625%
34. Company Risk Premium A company has a beta of 4.5. If the market return is expected
to be 14 percent and the risk-free rate is 7 percent, what is the company's risk premium?
A. 7.0%
B. 25.5%
C. 31.5%
D. 38.5%
A. 11.64%
B. 12.00%
C. 22.91%
D. 34.92%
10-8
36. Portfolio Beta You have a portfolio with a beta of 0.9. What will be the new portfolio
beta if you keep 40 percent of your money in the old portfolio and 60 percent in a stock with a
beta of 1.5?
A. 1.00
B. 1.20
C. 1.26
D. 2.40
beta of 1.75?
A. 1.00
B. 1.35
C. 1.50
D. 3.00
38. Stock Market Bubble If the NASDAQ stock market bubble peaked at 3,750, and two and
a half years later it had fallen to 2,200, what would be the percentage decline?
A. -15.87%
B. -17.05%
C. -41.33%
D. -58.67%
39. Stock Market Bubble If the Japanese stock market bubble peaked at 37,500, and two and
a half years later it had fallen to 25,900, what was the percentage decline?
A. -10.31%
B. -27.63%
C. -30.93%
D. -69.07%
10-9
40. Expected Return A company's current stock price is $84.50 and it is likely to pay a $3.50
dividend next year. Since analysts estimate the company will have a 10% growth rate, what is
its expected return?
A. 4.14%
B. 4.26%
C. 10.00%
D. 14.14%
41. Expected Return A company's current stock price is $65.40 and it is likely to pay a $2.25
dividend next year. Since analysts estimate the company will have a 11.25% growth rate,
what is its expected return?
A. 3.44%
B. 3.61%
C. 11.25%
D. 14.69%
42. Expected Return Risk Compute the standard deviation of the expected return given these
three economic states, their likelihoods, and the potential returns:
A. 6.8%
B. 16.5%
C. 21.5%
D. 46.4%
10-10
43. Expected Return Risk Compute the standard deviation of the expected return given these
three economic states, their likelihoods, and the potential returns:
A. 8.4%
B. 10.87%
C. 11.34%
D. 24.09%
44. Under/Over-Valued Stock A manager believes his firm will earn a 16 percent return next
year. His firm has a beta of 1.5, the expected return on the market is 14 percent, and the risk-
free rate is 4 percent. Compute the return the firm should earn given its level of risk and
determine whether the manager is saying the firm is under-valued or over-valued.
A. 19%, under-valued
B. 19%, over-valued
C. 22%, under-valued
D. 22%, over-valued
45. Under/Over-Valued Stock A manager believes his firm will earn a 12 percent return next
year. His firm has a beta of 1.2, the expected return on the market is 8 percent, and the risk-
free rate is 3 percent. Compute the return the firm should earn given its level of risk and
A. 9%, under-valued
B. 9%, over-valued
C. 13.8%, under-valued
D. 13.8%, over-valued
10-11
46. Under/Over-Valued Stock A manager believes his firm will earn a 7.5 percent return
next year. His firm has a beta of 2, the expected return on the market is 5 percent, and the
risk-free rate is 2 percent. Compute the return the firm should earn given its level of risk and
A. 8%, under-valued
B. 8%, over-valued
C. 12%, under-valued
D. 12%, over-valued
47. Portfolio Beta You own $2,000 of City Steel stock that has a beta of 2.5. You also own
$8,000 of Rent-N-Co (beta = 1.9) and $4,000 of Lincoln Corporation (beta = 0.25). What is
the beta of your portfolio?
A. 1.51
B. 1.55
C. 4.65
D. 14.00
48. Portfolio Beta You own $1,000 of City Steel stock that has a beta of 1.5. You also own
$5,000 of Rent-N-Co (beta = 1.8) and $4,000 of Lincoln Corporation (beta = 0.9). What is the
beta of your portfolio?
A. 1.4
B. 1.5
C. 4.2
D. 4.65
10-12
49. Expected Return and Risk Compute the standard deviation given these four economic
states, their likelihoods, and the potential returns:
A. 6.71%
B. 22.5%
C. 23.37%
D. 52.20%
A. 12.19%
B. 23.8%
C. 38.65%
D. 88.06%
10-13
A. 7.5%
B. 12.65%
C. 39.48%
D. 113.69%
52. Risk Premiums You own $14,000 of Diner's Corp stock that has a beta of 2.1. You also
own $14,000 of Comm Corp (beta = 1.3) and $12,000 of Airlines Corp (beta = 0.6). Assume
that the market return will be 15 percent and the risk-free rate is 6.5 percent. What is the total
risk premium of the portfolio?
A. 11.645%
B. 20.55%
C. 23.905%
D. 38.00%
53. Risk Premiums You own $5,000 of Software Corp's stock that has a beta of 3.75. You
also own $10,000 of Home Improvement Corp (beta = 1.5) and $15,000 of Publishing Corp
(beta = 0.35). Assume that the market return will be 13 percent and the risk-free rate is 4.5
percent. What is the risk premium of the portfolio?
A. 11.05%
B. 16.50%
C. 17.00%
D. 24.70%
10-14
54. Portfolio Beta and Required Return You hold the positions in the table below. What is
the beta of your portfolio? If you expect the market to earn 14 percent and the risk-free rate is
5 percent, what is the required return of the portfolio?
A. 20.21%
B. 22.66%
C. 28.66%
D. 32.48%
55. Portfolio Beta You hold the positions in the table below. What is the beta of your
portfolio?
A. 1.4
B. 2.08
C. 2.13
D. 5.6
10-15
56. Compute the expected return given these three economic states, their likelihoods, and the
potential returns:
A. 3.5%
B. 7.0%
C. 7.5%
D. 12.5%
57. The average annual return on the S&P 500 Index from 1986 to 1995 was 17.6 percent.
The average annual T-bill yield during the same period was 9.8 percent. What was the market
risk premium during these ten years?
A. 8.2%
B. 7.8%
C. 8.8%
D. 9.8%
58. Hastings Entertainment has a beta of 1.24. If the market return is expected to be 10
percent and the risk-free rate is 4 percent, what is Hastings' required return?
A. 11.44%
B. 12.44%
C. 14.96%
D. 16.40%
59. Netflicks, Inc. has a beta of 3.61. If the market return is expected to be 13.2 percent and
the risk-free rate is 7 percent, what is Netflicks' risk premium?
A. 20.91%
B. 22.38%
C. 25.72%
D. 29.38%
10-16
60. You have a portfolio with a beta of 3.1. What will be the new portfolio beta if you keep 85
percent of your money in the old portfolio and 15 percent in a stock with a beta of 4.5?
A. 3.31
B. 3.51
C. 3.61
D. 3.71
61. The Nasdaq stock market bubble peaked at 10,816 in 2000. Two and a half years later it
had fallen to 4,000. What was the percentage decline?
A. -63.02%
B. -69.47%
C. -57.13%
D. -49.18%
62. Paccar's current stock price is $75.10 and it is likely to pay a $3.29 dividend next year.
Since analysts estimate Paccar will have a 14.2% growth rate, what is its required return?
A. 15.39%
B. 17.94%
C. 18.58%
D. 19.62%
63. Universal Forest's current stock price is $154.00 and it is likely to pay a $5.23 dividend
next year. Since analysts estimate Universal Forest will have a 13.0% growth rate, what is its
required return?
A. 16.40%
B. 15.28%
C. 13.62%
D. 14.71%
10-17
64. A manager believes his firm will earn an 18 percent return next year. His firm has a beta
of 1.75, the expected return on the market is 13 percent, and the risk-free rate is 5 percent.
Compute the return the firm should earn given its level of risk and determine whether the
manager is saying the firm is under-valued or over-valued.
A. 19%; over-valued
B. 19%; under-valued
C. 16.7%; over-valued
D. 16.7%; under-valued
65. You own $9,000 of Olympic Steel stock that has a beta of 2.5. You also own $7,000 of
Rent-a-Center (beta = 1.2) and $8,000 of Lincoln Educational (beta = 0.4). What is the beta of
your portfolio?
A. 1.18
B. 1.07
C. 1.42
D. 1.53
66. Compute the expected return and standard deviation given these four economic states,
their likelihoods, and the potential returns:
A. 9.5%; 32.43%
B. 9.5%; 21.96%
C. 9.5%; 18.97%
D. 9.5%; 29.18%
10-18
67. You own $10,000 of Denny's Corp stock that has a beta of 3.2. You also own $15,000 of
Qwest Communications (beta = 1.9) and $15,000 of Southwest Airlines (beta = 0.4). Assume
that the market return will be 13 percent and the risk-free rate is 5.5 percent. What is the risk
premium of the portfolio?
A. 10.51%
B. 11.49%
C. 12.45%
D. 13.62%
68. You hold the positions in the table below. What is the beta of your portfolio? If you
expect the market to earn 12 percent and the risk-free rate is 3.5 percent, what is the required
return of the portfolio?
A. 14.21%
B. 16.76%
C. 13.97%
D. 15.38%
10-19
69. You hold the positions in the table below. What is the beta of your portfolio? If you
expect the market to earn 10 percent and the risk-free rate is 4 percent, what is the required
return of the portfolio?
A. 12.37%
B. 9.73%
C. 10.17%
D. 11.68%
70. Praxair's upcoming dividend is expected to be $2.25 and its stock is selling at $65. The
firm has a beta of 0.8 and is expected to grow at 10% for the foreseeable future. Compute
Praxair's required return using both CAPM and the constant growth model. Assume that the
market portfolio will earn 10 percent and the risk-free rate is 3 percent.
A. CAPM: 8.6%; Constant Growth Model: 13.46%
B. CAPM: 9.7%; Constant Growth Model: 12.56%
C. CAPM: 10.1%; Constant Growth Model: 11.46%
D. CAPM: 8.2%; Constant Growth Model: 9.56%
71. Estee Lauder's upcoming dividend is expected to be $0.65 and its stock is selling at $45.
The firm has a beta of 1.1 and is expected to grow at 10% for the foreseeable future. Compute
Estee Lauder's required return using both CAPM and the constant growth model. Assume that
the market portfolio will earn 11 percent and the risk-free rate is 4 percent.
A. CAPM: 11.2%; Constant Growth Model: 10.97%
B. CAPM: 11.7%; Constant Growth Model: 11.44%
C. CAPM: 10.1%; Constant Growth Model: 11.46%
D. CAPM: 9.2%; Constant Growth Model: 9.56%
10-20
72. ABC Inc. has a dividend yield equal to 3% and is expected to grow at a 7% rate for the
next 7 years. What is ABC's required return?
A. 10%
B. 11%
C. 4%
D. 5%
73. US Bancorp holds a press conference to announce a positive news event that was
unexpected to the market. As soon as the announcement is made, the stock price increases $8
per share but then over the next hour the price continues to increase resulting in a total
increase of $11. Given this information which of the following statements is correct?
A. This is an example of a market overreaction.
B. This is an example of a market underreaction.
C. This is an example of a semi-strong efficient market.
D. None of these statements are correct.
74. US Bancorp holds a press conference to announce a positive news event that was
unexpected to the market. As soon as the announcement is made, the stock price increases $8
per share but then over the next hour the price falls resulting in a net increase of only $4.
Given this information which of the following statements is correct?
A. This is an example of a market overreaction.
B. This is an example of a market underreaction.
C. This is an example of a semi-strong efficient market.
75. Which of the following is incorrect?

A. Technical analysis is expected to work if markets are weak-form efficient.
B. If markets are strong-form efficient then they must also be weak-form efficient.
C. It is not likely that the market is strong-form efficient.
D. None of these statements are incorrect.
10-21
76. Which of the following is correct?

A. Hedge funds often sell stock they don't even own.
B. Hedge funds maintain secrecy about their holdings, trading and strategies.
C. Hedge funds are limited to sophisticated investors.
D. All of these statements are correct.
77. Which of the following statements is incorrect?

A. The capital market line shows the relationship between return and risk as measured by the
standard deviation.
B. The Efficient Market Hypothesis states that security prices fully reflect all available
information.
C. The security market line shows the relationship between return and risk as measured by
beta.
78. Stock A has a required return of 19%. Stock B has a required return of 11%. Assume a
risk-free rate of 4.75%. Which of the following is a correct statement about the two stocks?
A. Stock A is riskier.
B. Stock B is riskier.
C. The stocks have the same risk.
D. We would need to know if the markets are efficient to answer this question.
risk-free rate of 4.75%. By how much does Stock A's risk premium exceed the risk premium
of Stock B?
A. 3.25%
B. 6.25%
C. 8.00%
D. 7.00%
10-22
risk-free rate of 4.75%. Which of the following is a correct statement about the two stocks?
A. Stock A is riskier.
B. Stock B is riskier.
C. The stocks have the same risk.
D. We would need to know if the markets are efficient to answer this question.
81. IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm
to grow at 10% per year for the next 5 years. TDI's stock price is $10, it is expected to pay a
$1 dividend, and analysts expect the firm to grow at 12% per year for the next 5 years. What
is the difference in the two firms' required rate of returns?
A. 2.91%
B. 1.82%
C. 2.03%
D. 3.23%
82. Which of the following statements is correct?

A. If the market is strong-form efficient it must also be weak-form efficient and semi-strong
efficient.
B. There is evidence to suggest that the market is strong-form efficient because corporate
insiders have made extraordinary profits by trading on inside information.
C. The Efficient Market Hypothesis states that security prices will be based on their expected
return.
D. None of these statements is correct.
83. IBM has a beta of 1.0 and Apple Computer has a beta of 3.0. Which of the following
statements must be correct?
A. The market risk premium for Apple must be larger than the market risk premium of IBM.
B. If investors become more risk averse, the expected return of Apple will increase more than
the expected return on IBM.
C. Apple's expected rate of return must be three times as large as IBM's.
10-23
84. You hold a diversified portfolio consisting of $1,000 investment in each of 10 different
stocks. The portfolio has a beta of 0.8. You have decided to sell one of your stocks that has a
beta equal to 1.1 for $1,000. You will purchase $1,000 of a new stock with a beta of 2.5. After
these two transactions (sell and buy), what will be the beta of the new portfolio?
A. 1.1
B. 0.99
C. 0.87
D. 0.94
85. A stock has an expected return of 14.5%, the risk-free rate is 4% and the return on the
market is 11%. What is this stock's beta?
A. 1.5
B. 3.0
C. 1.05
D. .94
86. In 2000, the S&P500 Index earned 11% while the T-bill yield was 4.4%. Given this
information, which of the following statements is correct with respect to the market risk
premium?
A. The market risk premium must have been negative.
B. The market risk premium must have been positive.
C. The market risk premium must have been zero.
D. Unable to answer without more information.
87. How might a small market risk premium impact people's desire to buy stocks?
A. Investors with high risk aversion will be less willing to invest in stocks.
B. Investors with high risk aversion will be more willing to invest in stocks.
C. It will only impact the share prices.
10-24
88. How might a large market risk premium impact people's desire to buy stocks?
A. Investors with high risk aversion will be less willing to invest in stocks.
B. Investors with high risk aversion will be more willing to invest in stocks.
C. It will only impact the share prices.
89. Consider an asset that provides the same return no matter what economic state occurs.
What would be the standard deviation of this asset?
A. Unable to answer since there is no data to calculate the standard deviation.
B. A very low number since it would have very low risk.
C. 1
D. 0
90. Whenever a set of stock prices go unnaturally high and subsequently crash down, the
market experiences what we call a(n) ___________________.
A. Financial meltdown
B. Irrational behavior
C. Stock market bubble
D. None of these
91. All of the following are necessary conditions for an efficient market except _________.
A. Low trading or transaction costs
B. Many buyers and sellers
C. Free and readily available information to market participants
D. Low stock prices
92. Which of the following is most correct?

A. In an efficient market, investors will buy overvalued stock which will drive its price down.
B. In an efficient market, investors will sell undervalued stock which will drive its price
down.
C. In an efficient market, investors will sell overvalued stock which will drive its price down.
10-25
93. Which of the following statements is incorrect?

A. The Security Market Line shows the relationship between risk and return for any stock or
portfolio.
B. The y-intercept of the Security Market Line represents the return on the risk-free asset.
C. The measure of risk used in creating the Security Market Line is the standard deviation.
94. Which of the following statements is correct?

A. Penny stocks are the stocks of small companies that are priced below $1 per share.
B. Restricted stocks are shares of stock issued to executives that have limitations on voting
rights.
C. The Capital Market Line graphs the relationship between return and risk (beta).
D. All of these statements are correct.
economic decisions is known as _______________.
A. Efficient Thinking Hypothesis
B. Financial Cognition
C. Financial Leverage
D. Behavioral Finance
96. You obtain beta estimates of General Electric from two different online sources and you
are surprised to find that they are so different. Which of the following would not be a correct
explanation for the difference?
A. One source used weekly data and another used monthly data.
B. One source used the S&P500 for a market proxy and the other used the Dow Jones
Industrial Average.
C. One used regression analysis and the other used geometric analysis.
D. All of these are correct explanations for the difference.
10-26
97. Which of the following is incorrect?

A. Most firms would want to sell additional shares of common stock if they feel their stock is
undervalued.
B. Most firms would not want to repurchase shares of common stock if they feel their stock is
overvalued.
C. It is important for financial managers to understand market efficiency because it helps
them understand how their stock prices will react to different types of decisions and news
announcements.
98. Which of the following is a concern regarding beta?

A. Using different market proxies will result in different estimates of beta.
B. A company can alter its risk level which may make the beta estimate obsolete.
C. Research indicates that a company's beta does not appear to predict its future return very
well.
D. All of these statements are valid concerns regarding beta.
99. Which of the following statements is incorrect regarding how beta is calculated?
A. The company return is the independent variable.
B. The market portfolio return is the dependent variable.
C. Using the oldest data possible will yield the most accurate results.
D. All of these statements are incorrect.
100. You have a portfolio consisting of 20% Boeing (beta = 1.3) and 40% Hewlett-Packard
(beta = 1.6) and 40% McDonald's stock (beta = 0.7). How much market risk does the portfolio
have?
A. This portfolio has 18% less risk than the general market.
B. This portfolio has 28% more risk than the general market.
C. This portfolio has 18% more risk than the general market.
D. This portfolio has 28% less risk than the general market.
10-27
101. Expected Return A company's current stock price is $22.00 and its most recent
dividend was $0.75 per share. Since analysts estimate the company will have a 12% growth
rate, what is its expected return?
A. 3.00%
B. 3.48%
C. 12.00%
D. 15.82%
Essay Questions
102. Describe how adding a risk-free security to modern portfolio theory allows investors to
do better than the efficient frontier.
103. Land O Lakes Systems has a beta of 1.66. Does this mean that you should expect Land O
Lakes to earn a return 88 percent higher than the S&P500 Index return? Explain.
10-28
104. Required Return Using the information in the table, compute the required return for
each company using both CAPM and the constant growth model. Compare and discuss the
results. Assume that the market portfolio will earn 11 percent and the risk-free rate is 2.5
percent.
105. List and describe the three basic levels of market efficiency,
106. The constant growth model requires what information for computing shareholders'
required return?
10-29
Chapter 10 Estimating Risk and Return Answer Key
Multiple Choice Questions
1. Which of the following is a true statement?

A. The risk and return that a firm experienced in the past is also the risk level for its future.
B. Firms can quite possibly change their stocks' risk level by substantially changing their
business.
C. If a firm takes on riskier new projects over time, the firm itself will become less risky.
D. If a firm takes on less risky new projects over time, the firm itself will become more risky.
AACSB: Reflective Thinking

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 10-01 Compute forward-looking expected return and risk.
Topic: Expected return
2. This is the average of the possible returns weighted by the likelihood of those returns
occurring.
A. efficient return
B. expected return
C. market return
D. required return

Blooms: Remember
Difficulty: 1 Basic
10-30
3. The set of probabilities for all possible occurrences.

A. probability
B. probability distribution
C. stock market bubble
D. market probabilities

Blooms: Remember
Difficulty: 1 Basic
4. This is typically considered the return on U.S. government bonds and bills and equals the
real interest plus the expected inflation premium.
A. required return
B. risk-free rate
C. risk premium

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 10-02 Understand risk premiums.
Topic: Risk premiums
5. This is the reward investors require for taking risk.

A. required return
B. risk-free rate
C. risk premium

Blooms: Remember
Difficulty: 1 Basic
10-31
6. This is the reward for taking systematic stock market risk.

A. required return
B. risk-free rate
C. risk premium

Blooms: Remember
Difficulty: 1 Basic
7. This model includes an equation that relates a stock's required return to an appropriate risk
premium:
A. asset pricing
C. beta
D. efficient markets

Blooms: Remember
Difficulty: 1 Basic
8. The asset pricing theory based on a beta, a measure of market risk.

A. Behavioral Asset Pricing Model
B. Capital Asset Pricing Model
C. Efficient Markets Asset Pricing Model

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 10-03 Know and apply the Capital Asset Pricing Model (CAPM).
Topic: CAPM
10-32
9. In theory, this is a combination of securities that places the portfolio on the efficient
frontier and on a line tangent from the risk-free rate.
A. efficient market
B. market portfolio
C. probability distribution

Blooms: Remember
Difficulty: 1 Basic
Topic: CAPM
10. The use of debt to increase an investment position.

B. financial leverage
C. probability

Blooms: Remember
Difficulty: 1 Basic
Topic: CAPM
11. Which of these is the line on a graph of return and risk (standard deviation) from the risk-
free rate through the market portfolio?
A. Capital Asset Pricing Line
B. Capital Market Line
C. Efficient Market Line

Blooms: Remember
Difficulty: 1 Basic
Topic: CAPM
10-33
12. A measure of the sensitivity of a stock or portfolio to market risk.

B. beta
C. efficient market
D. hedge

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 10-04 Calculate and apply beta; a measure of market risk.
Topic: Beta
13. Similar to the Capital Market Line except risk is characterized by beta instead of standard
deviation.
A. Market Risk Line
B. Probability Market Line
C. Security Market Line
D. Stock Market Line

Blooms: Remember
Difficulty: 1 Basic
Topic: CAPM
14. Which of these is the measurement of risk for a collection of stocks for an investor?
A. beta
B. efficient market
C. expected return
D. portfolio beta

Blooms: Remember
Difficulty: 1 Basic
Topic: CAPM
10-34
15. Which of the following is NOT a necessary condition for an efficient market?
A. Many buyers and sellers.
B. No prohibitively high barriers to entry.
C. Free and readily available information available to all participants.
D. No trading or transaction costs.

Blooms: Remember
Difficulty: 2 Intermediate
Learning Objective: 10-05 Differentiate among the different levels of market efficiency and their implications.
Topic: Levels of market efficiency
16. The stocks of small companies that are priced below $1 per share.
A. bargain stocks
B. hedge fund stocks
C. penny stocks
D. stock market bubble stocks

Blooms: Remember
Difficulty: 1 Basic
17. A theory that describes the types of information that are reflected in current stock prices.
A. asset pricing

Blooms: Remember
Difficulty: 1 Basic
10-35
18. This is data that includes past stock prices and volume, financial statements, corporate
news, analyst opinions, etc.
B. generally accepted accounting principles

Blooms: Remember
Difficulty: 1 Basic
19. This has not been released to the public, but is known by few individuals, likely company
insiders.
B. restricted stock
D. insider trading

Blooms: Remember
Difficulty: 1 Basic
20. Investor enthusiasm causes an inflated bull market that drives prices too high, ending in a
dramatic collapse in prices.
A. behavior finance
B. efficient market

Blooms: Remember
Difficulty: 1 Basic
10-36
economic decisions.
A. asset pricing model

Blooms: Remember
Difficulty: 1 Basic
22. Shares of stock issued to employees that have limitations on when they can be sold.
C. restricted stock

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 10-06 Calculate and explain investors' required return and risk.
Topic: Investor risk
23. Special rights given to some employees to buy a specific number of shares of the company
stock at a fixed price during a specific period of time.
C. restricted stock

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 10-06 Calculate and explain investors' required return and risk.
Topic: Investor risk
10-37
24. The constant growth model assumes which of the following?

A. That there is privately held information.
B. That the stock is efficiently priced.
C. That there are executive stock options available to managers.
D. That there is no restricted stock.

Blooms: Remember
Difficulty: 2 Intermediate
Learning Objective: 10-07 Use the constant-growth model to compute required return.
Topic: Constant growth rate model
A. 6.8%
B. 12.8%
C. 16.0%
D. 22.7%
Expected return = 0.1 x 50% + 0.6 x 8% + 0.3 x -10% = 6.8%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
10-38
A. 13.5%
B. 22.5%
C. 18.3%
D. 40.0%
Expected return = 0.3 x 40% + 0.4 x 15% + 0.3 x -15% = 13.5%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
A. 2%
B. 6%
C. 8%
D. 10%
Required return = 8% + 2% = 10%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
10-39
A. 4%
B. 7%
C. 10%
D. 14%
Required return = 10% + 4% = 14%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
that year?
A. 5.7%
B. 6.7%
C. 12.4%
D. 18.1%
Average market risk premium = 12.4% - 5.7% = 6.7%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
10-40
that year?
A. 6.2%
B. 11.9%
C. 18.1%
D. 24.3%
Average market risk premium = 18.1% - 6.2% = 11.9%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
to be 12 percent and the risk-free rate is 5 percent, what is the company's required return?
A. 6.0%
B. 8.5%
C. 11.0%
D. 13.5%
Required return = 5% + 0.50 x (12% - 5%) = 8.5%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
Topic: CAPM
10-41
A. 22.750%
B. 33.125%
C. 45.500%
D. 51.000%
Required return = 5.5% + 3.25 x (14% - 5.5%) = 33.125%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
Topic: CAPM
A. 33.250%
B. 39.375%
C. 48.875%
D. 55.625%
Required return = 9.5% + 3.75 x (20% - 9.5%) = 48.875%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
Topic: CAPM
10-42
A. 7.0%
B. 25.5%
C. 31.5%
D. 38.5%
Risk premium = 4.5 x (14% - 7%) = 31.5%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
Topic: CAPM
A. 11.64%
B. 12.00%
C. 22.91%
D. 34.92%
Risk premium = 2.91 x (16% - 4%) = 34.92%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
Topic: CAPM
10-43
beta of 1.5?
A. 1.00
B. 1.20
C. 1.26
D. 2.40
New portfolio beta = 0.40 x 0.9 + 0.60 x 1.5 = 1.26
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
Topic: CAPM
beta of 1.75?
A. 1.00
B. 1.35
C. 1.50
D. 3.00
New portfolio beta = 0.80 x 1.25 + 0.20 x 1.75 = 1.35
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
Topic: CAPM
10-44
38. Stock Market Bubble If the NASDAQ stock market bubble peaked at 3,750, and two and
a half years later it had fallen to 2,200, what would be the percentage decline?
A. -15.87%
B. -17.05%
C. -41.33%
D. -58.67%
Market decline = (2,200 - 3,750) 3,750 = -0.4133 = -41.33%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
39. Stock Market Bubble If the Japanese stock market bubble peaked at 37,500, and two and
a half years later it had fallen to 25,900, what was the percentage decline?
A. -10.31%
B. -27.63%
C. -30.93%
D. -69.07%
Market decline = (25,900 - 37,500) 37,500 = -0.3093 = -30.93%
AACSB: Analytical
Blooms: Apply
Difficulty: 1 Basic
10-45
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verran samansisältöisiä balladeja. Sisällöltään lähempänä on
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laulu papin pojasta Aljoshkasta, jonka aiheena niinikään on
tuntemattoman sisarensa naiminen.
Kuvauksen Kullervon sodanhalusta on Lönnrot saanut alkuaan

aivan itsenäisistä runoista, joita jo laulajat kumminkin useissa
tapauksissa yhdistivät olennaisena piirteenä Kullervon luonteeseen.
Sampsa Pellervoisen arvellaan saaneen alkunsa germaanisesta

jumalaistarustosta. Nimi Sampsa eli Sämpsä johtunee sämpsykkä-
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säkeellä: Anni tytti, aino tytti, muodosti Lönnrot aino-sanasta
ominaisnimen siten että kirjoitti sen isolla alkukirjaimella. Aino-runo
Kalevalassa on pääasiallisesti kokoonpantu venäjänkarjalaisista
toisinnoista. Niissä kerrotaan, miten Anni menee metsään vastaksia
taittamaan, jolloin Osmoinen tai Kalevainen tulee häntä kosinta-
aikeissa mairittelemaan. Anni juokse silloin pahastuneena itkien
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lohduttelee tytärtään ja neuvoo häntä aitassa pukeutumaan
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kehittynyt kolmesta itsenäisestä laulusta, nimittäin runoista: Katri ja
Riion poika, Koristeensa kadottanut tyttö ja kyyneleiden vierinnästä
ynnä tytölle kukkuvasta kolmesta käestä. Eteläiseltä runoalueelta on
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toiminnasta, että sen ovat muutamat katsoneet olevan ikäänkuin
koko eepoksen koossapitävän keskuksen. Ja eniten kaikista
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tarun ympärille. Minkäänlaista varmaa selitystä, jota yleiseen olisi
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merkityksen. Nimityksestä ei ole päästy yksimielisyyteen, mutta
runojen kehityksen tutkimuksesta on käynyt selville, että runon
ytimenä on ollut legendan-tapainen Päivänpäästöruno.
Krohn on huomauttanut laulajain selitysten, että ellei
Väinämöiseltä olisi hajotettu Sampoa, ei täällä olisi halloja eikä
Pohjan tuulia, eikä maa köyhä, meri pohatta, olevan »itse luonnon
opettamia Pohjan perän asukkaille. Kansamme kova kokemus, ettei
täyttä eheätä onnea täällä ei ole saavutettavissa, on Sampo-virteen
leimansa painanut. Onhan Suomen kansa kaikissa suhteissa saanut
tyytyä ikäänkuin Sammon muruihin. Mutta se on myös oppinut näistä
sirpaleista elämän mahdollisuutta luomaan.»
Ja sirpaleistahan kansamme on luonut merkillisen eepoksensakin.

Monesta on ehkä tuntunu ikävältä kun tutkijat ovat noista runoista ja
niiden sankareista poistaneet tarunomaisen muinaisuuden hohteen
osoittaessaan vain osan olevan puhdasta perua esi-isiemme
pakanallisesta jumalaistarustosta ja kotimaisista historiallisista
aiheista ja melkoisen osan olevan lainaa kristillisestä aatepiiristä
sekä muutamien naapurikansoilta. Mutta tulee ottaa huomioon, että
vaikkakin muutamat muilta lainatut tarut ovat olleet sinä alkuaiheena,
joka on saanut suomalaisen mielikuvituksen liikkeelle, niin on
tuloksena ollut aivan omintakeinen runous, jossa kansamme
omaperäisellä tavalla ja sävyllä, niinkuin mikään muu heimo
maailmassa ei olisi sitä tehnyt, on antanut kuvan itsestään, siitä
mitkä mielikuvitukset, haaveet, harhaluulot ja vaistot vuosituhansien
kuluessa ovat syöpyneet tämän mietiskelevän metsien heimon
veriin.
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Finance Applications and Theory 2Nd Edition Cornett Test Bank Full Chapter PDF

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Finance Applications and Theory 2nd

Edition Cornett Test Bank

Multiple Choice Questions

1. Which of the following is a true statement?

3. The set of probabilities for all possible occurrences.

5. This is the reward investors require for taking risk.

6. This is the reward for taking systematic stock market risk.

8. The asset pricing theory based on a beta, a measure of market risk.

10. The use of debt to increase an investment position.

12. A measure of the sensitivity of a stock or portfolio to market risk.

24. The constant growth model assumes which of the following?

75. Which of the following is incorrect?

76. Which of the following is correct?

77. Which of the following statements is incorrect?

82. Which of the following statements is correct?

92. Which of the following is most correct?

93. Which of the following statements is incorrect?

94. Which of the following statements is correct?

97. Which of the following is incorrect?

98. Which of the following is a concern regarding beta?

Chapter 10 Estimating Risk and Return Answer Key

Multiple Choice Questions

1. Which of the following is a true statement?

AACSB: Reflective Thinking

AACSB: Reflective Thinking

3. The set of probabilities for all possible occurrences.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

5. This is the reward investors require for taking risk.

AACSB: Reflective Thinking

6. This is the reward for taking systematic stock market risk.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

8. The asset pricing theory based on a beta, a measure of market risk.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

10. The use of debt to increase an investment position.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

12. A measure of the sensitivity of a stock or portfolio to market risk.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

24. The constant growth model assumes which of the following?

AACSB: Reflective Thinking

Expected return = 0.1 x 50% + 0.6 x 8% + 0.3 x -10% = 6.8%

Expected return = 0.3 x 40% + 0.4 x 15% + 0.3 x -15% = 13.5%

Required return = 8% + 2% = 10%

Required return = 10% + 4% = 14%

Average market risk premium = 12.4% - 5.7% = 6.7%

Average market risk premium = 18.1% - 6.2% = 11.9%

Required return = 5% + 0.50 x (12% - 5%) = 8.5%

Required return = 5.5% + 3.25 x (14% - 5.5%) = 33.125%