Financial Management

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MBA 579 Homework Assignment 4-2

True/False
Indicate whether the statement is true or false.

____1.The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

____2.The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

____3.An individual stock's diversifiable risk, which is measured by the stock's beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

____4.A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

____5.The slope of the SML is determined by the value of beta.

____6.The slope of the SML is determined by investors' aversion to risk. The greater the marginal investor's risk aversion, the steeper the SML.

____7.The exercise value is the positive difference between the current price of the stock and the strike price. The exercise value is zero if the stock's price is below the strike price.

____8.Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.

____9.If a project's NPV exceeds its IRR, then the project should be accepted.

____10.The NPV method's assumption that cash inflows are reinvested at the cost of capital is more reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.

Multiple Choice
Identify the choice that best completes the statement or answers the question.

____11.Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT? a.| Portfolio P has a beta that is greater than 1.2.|

b.| Portfolio P has a standard deviation that is greater than 25%.| c.| Portfolio P has an expected return that is less than 12%.| d.| Portfolio P has a standard deviation that is less than 25%.| e.| Portfolio P has a beta that is less than 1.2.|

____12.Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur? a.| The required return on a stock with beta = 1.0 will not change.| b.| The required return on a stock with beta > 1.0 will increase.| c.| The return on "the market" will remain constant.|

d.| The return on "the market" will increase.|
e.| The required return on a stock with beta < 1.0 will decline.|

____13.Keith Johnson has $100,000 invested in a 2-stock portfolio. $30,000 is invested in Potts Manufacturing and the remainder is invested in Stohs Corporation. Potts' beta is 1.60 and Stohs' beta is 0.60. What is the portfolio's beta? a.| 0.60|

b.| 0.66|
c.| 0.74|
d.| 0.82|
e.| 0.90|

____14.A stock has an expected return of 12.60%. Its beta is 1.49 and the risk-free rate is 5.00%. What is the market risk premium? a.| 5.10%|
b.| 5.23%|
c.| 5.36%|
d.| 5.49%|
e.| 5.63%|

____15.Ritter Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is Ritter's required rate of return? a.| 11.36%|
b.| 11.65%|
c.| 11.95%|
d.| 12.25%|
e.| 12.55%|

____16.The preemptive right is important to shareholders because it a.| Allows managers to buy additional shares below the current market price.| b.| Will result in higher dividends per share.|

c.| Is included in every corporate charter.|
d.| Protects the current shareholders against a dilution of their ownership interests.| e.| Protects bondholders, and thus...
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