FINS1613

Topics: Capital asset pricing model, Weighted average cost of capital, Stock Pages: 7 (1295 words) Published: June 15, 2015
Australian School Of Business
FINS1613: Business Finance
Semester 1 2013
Tutorial Quiz 4

Name:
STUDENT NAME
Student number: STUDENT NUMBER
Tutorial:

TUTORIAL

Instructions:
1. You must complete a Generalised Answer Sheet for this exam. (a) Complete the top portion of the sheet, providing your family name, initials, and student number.
(b) If you are taking a quiz marked Extra, record the quiz number under Other Data. If you are taking a quiz preprinted with your student information, leave Other Data blank.
(c) Answer all questions using the generalised answer sheet. Clearly fill in the response oval using a 2B pencil.
2. You must not retain any part of this examination document. All examination materials including this document must be submitted at the completion of the examination, otherwise your exam will not be marked. 3. All exams are unique and linked to your student number. Sign below to confirm that your name and student number listed above are correct. Signature:

Information:
1. Time allowed: 20 minutes
2. Grading:
(a) Total marks available: 100 marks
(b) This examination paper consists of 6 (six) multiple choice questions worth 16 (sixteen) marks each.
(c) Correctly recording your student ID on the generalised answer sheet is worth 4 (four) marks.
(d) All questions are graded on a correct/incorrect basis. There is no penalty for answering a question incorrectly.
3. Unless otherwise specified, each question is independent of the others and assumptions from one question do not carry over to the others. 4. Use of a calculator is allowed.
5. Some useful equations are printed below.
(a) Standard deviation:
n

(ri − r¯)2
i=1

σ(r) =

n−1

(b) Variance of a portfolio:
σ 2 = w12 σ12 + w22 σ22 + 2w1 w2 σ1 σ2 cov(R1 , R2 )
= w12 σ12 + w22 σ22 + 2w1 w2 σ1 σ2 ρ1,2

(c) Weighted average cost of capital:
W ACC = ke ×

D
E
+ kd (1 − t) ×
V
V

GOOD LUCK!

Q UESTIONS 1 AND 2 (16 MARKS EACH )
1. Inflation, recession, and high interest rates are economic events that are characterized as
.
(a) systematic risk that can be diversified away
(b) unsystematic risk that can be diversified away
(c) company-specific risk that can be diversified away
(d) market risk that can not be diversified away
(e) none of the above
Answer: d
Inflation, recession, and interest rates are economy wide events that affect all financial securities. They remain even in a well-diversified portfolio.

2. Stock X has a beta of 2.1 and Stock Y has a beta of 2.6. Which of the following statements must be correct?
(a) If expected inflation increases but the market risk premium is unchanged, Stock Y will have a greater increase in required return than Stock X.
(b) If the market risk premium increases but the risk-free rate is unchanged, Stock Y will have a greater increase in required return than Stock X.
(c) Stock Y’s return has a higher standard deviation than Stock X. (d) Stock Y’s return this year will be higher than Stock X’s return. (e) Stock Y’s return has a lower standard deviation than Stock X. Answer: b

The question is an application of the CAPM. For any stock,
rE = rf + β × M arket Risk P remium
If the market risk premium increases and the risk-free doesn’t change then the stock with the higher beta will have a larger increase in its cost of equity, re . Answers c and e are incorrect since the CAPM talks about systematic risk. There is no information on the stocks’ unsystematic risk and, therefore, it is impossible to draw conclusions about the stocks’ overall risk and standard deviation. Answer d is incorrect because the CAPM gives only a cost of equity or an expected return. In any year, actual realized returns may be higher or lower than expected return.

1

Q UESTIONS 3 AND 4 (16

MARKS EACH )

3. Leo is going to invest across two stocks and the risk-free asset as specified below:
Asset

Portfolio Weight

Beta

29%
71%

1.7
1.0

Gatsby Inc.
Titanic and Co....
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