7) Using the average historical excess returns for both Wyatt Oil and the Market portfolio, your estimate
of Wyatt Oil’s Beta is closest to:
A) 0.75
B) 0.84
C) 1.00
D) 1.19
8) Using the average historical excess returns for both Wyatt Oil and the Market portfolio estimate of
Wyatt Oil’s Beta. When using this beta, the alpha for Wyatt oil in 2007 is closest to:
A) -0.5000%
B) -0.0250%
C) -0.0125%
D) +0.0250%
9) Using just the return data for 2009, your estimate of Wyatt Oil’s Beta is closest to:
A) 0.84
B) 0.87
C) 1.00
D) 1.16
10) Using just the return data for 2008, your estimate of Wyatt Oil’s Beta is closest to:
A) 0.85
B) 0.87
C) 1.00
D) 1.17
11) Which of the following statements is FALSE?
A) Beta is the expected percent change in the excess return of the security for a 1% change in the excess
return of the market portfolio.
B) Beta represents the amount by which risks that affect the overall market are amplified for a given
stock or investment.
C) It is common practice to estimate beta based on the historical correlation and volatilities.
D) Beta measures the diversifiable risk of a security, as opposed to its market risk, and is the
appropriate measure of the risk of a security for an investor holding the market portfolio.
12) Which of the following statements is FALSE?
A) One difficulty when trying to estimate beta for a security is that beta depends on the correlation and
volatilities of the security’s and market’s returns in the future.
B) It is common practice to estimate beta based on the expectations of future correlations and
volatilities.
C) One difficulty when trying to estimate beta for a security is that beta depends on investors’
expectations of the correlation and volatilities of the security’s and market’s returns.
D) Securities that tend to move less than the market have betas below 1.
13) Which of the following statements is FALSE?
A) Securities that tend to move more than the market have betas lower than 0.
B) Securities whose returns tend to move in tandem with the market on average have a beta of 1.
C) Beta corresponds to the slope of the best fitting line in the plot of the securities excess returns versus
the market excess return.
D) The statistical technique that identifies the bets-fitting line through a set of points is called linear
regression.
14) The bi in the regression:
A) measures the sensitivity of the security to market risk.
B) measures the historical performance of the security relative to the expected return predicted by the
SML.
C) measures the deviation from the best fitting line and is zero on average.
D) measures the diversifiable risk in returns.
15) The ai in the regression:
A) measures the sensitivity of the security to market risk.
B) measures the deviation from the best fitting line and is zero on average.
C) measures the diversifiable risk in returns.
D) measures the historical performance of the security relative to the expected return predicted by the
SML.
16) The ei in the regression:
A) measures the market risk in returns.
B) measures the deviation from the best fitting line and is zero on average.
C) measures the sensitivity of the security to market risk.
D) measures the historical performance of the security relative to the expected return predicted by the
SML.
12.4 The Debt Cost of Capital
Use the following information to answer the question(s) below.
Consider the following information regarding corporate bonds:
Rating
BBB
BB
B
CCC
Average Default Rate
0.5%
2.2%
5.5%
12.2%
Recession Default Rate
3.0%
8.0%
16.0%
48.0%
Average Beta
0.10
0.17
0.26
0.31
1) Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and
a BBB rating. The corresponding risk-free rate is 3% and the market risk premium is 5%. Assuming a
normal economy, the expected return on Wyatt Oil’s debt is closest to:
A) 3.0%
B) 3.5%
C) 4.9%
D) 5.5%
2) Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and
a BBB rating. The bondholders’ expected loss rate in the event of default is 70%. Assuming a normal
economy the expected return on Wyatt Oil’s debt is closest to:
A) 3.0%
B) 3.5%
C) 4.9%
D) 6.7%
3) Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and
a BBB rating. The bondholders’ expected loss rate in the event of default is 70%. Assuming the economy
is in recession, then the expected return on Wyatt Oil’s debt is closest to:
A) 3.5%
B) 4.9%
C) 5.5%
D) 7.0%
4) Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%,
and a B rating. The corresponding risk-free rate is 3% and the market risk premium is 6%. Assuming a
normal economy, the expected return on Rearden Metal’s debt is closest to:
A) 0.6%
B) 1.6%
C) 4.6%
D) 6.0%
5) Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%,
and a B rating. The bondholders expected loss rate in the event of default is 50%. Assuming a normal
economy the expected return on Rearden Metal’s debt is closest to:
A) 0.6%
B) 1.6%
C) 4.6%
D) 6.0%
6) Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%,
and a B rating. The bondholders expected loss rate in the event of default is 50%. Assuming the
economy is in recession, then the expected return on Rearden Metal’s debt is closest to:
A) 0.6%
B) 1.6%
C) 4.6%
D) 6.0%
7) Nielson Motors plans to issue 10-year bonds that it believes will have an BBB rating. Suppose AAA
bonds with the same maturity have a 3.5% yield. Assume that the market risk premium is 5% and the
expected loss rate in the event of default on the bonds is 60%. The yield that these bonds will have to
pay during average economic times is closest to:
A) 3.50%
B) 3.75%
C) 4.00%
D) 5.50%
8) Nielson Motors plans to issue 10-year bonds that it believes will have an BBB rating. Suppose AAA
bonds with the same maturity have a 3.5% yield. Assume that the market risk premium is 5% and the
expected loss rate in the event of default on the bonds is 60%. The yield that these bonds will have to
pay during a recession is closest to:
A) 3.50%
B) 3.75%
C) 4.00%
D) 5.50%
12.5 A Project’s Cost of Capital
Use the following information to answer the question(s) below.
Consider the following information regarding corporate bonds:
Rating
BBB
BB
B
CCC
Average Default Rate
0.45%
2.2%
5.5%
12.2%
Recession Default Rate
3.0%
8.0%
16.0%
48.0%
Average Beta
0.10
0.17
0.26
0.31
Company
Market
Capitalization
($mm)
Total
Enterprise
Value ($mm)
Equity
Beta
Debt
Rating
Taggart Transcontinental
$4500
8000
1.1
BBB
Rearden Metal
$3800
7200
1.3
AAA
Wyatt Oil
$2400
3800
0.9
A
Nielson Motors
$1500
4400
1.75
BB
1) Your estimate of the debt beta for Taggart Transcontinental would be:
A) 0.05
B) 0.10
C) 0.17
D) 1.00
2) Your estimate of the debt beta for Nielson Motors would be:
A) 0.10
B) 0.17
C) 1.00
D) 1.68
3) Your estimate of the asset beta for Taggart Transcontinental is closest to:
A) 0.42
B) 0.59
C) 0.66
D) 0.71
4) Your estimate of the asset beta for Rearden Metal is closest to:
A) 0.42
B) 0.59
C) 0.66
D) 0.71
5) Your estimate of the asset beta for Wyatt Oil is closest to:
A) 0.59
B) 0.66
C) 0.71
D) 0.90
6) Your estimate of the asset beta for Nielson Motors is closest to:
A) 0.59
B) 0.66
C) 0.71
D) 1.75
7) Suppose that because of the large need for steel in building railroad infrastructure, Taggart
Transcontinental and Rearden Metal decide to form into one large conglomerate. Your estimate of the
asset beta for this new conglomerate is closest to:
A) 0.42
B) 0.59
C) 0.66
D) 0.68
Use the following information to answer the question(s) below.
Consider the following information regarding corporate bonds:
Rating
BBB
BB
B
CCC
Average Default Rate
0.5%
2.2%
5.5%
12.2%
Recession Default Rate
3.0%
8.0%
16.0%
48.0%
Average Beta
0.10
0.17
0.26
0.31
8) Galt Industries has a market capitalization of $50 billion, $30 billion in BBB rated debt, and $8 billion
in cash. If Galt’s equity beta is 1.15, then Galt’s underlying asset beta is closest to:
A) 0.83
B) 0.92
C) 1.00
D) 1.15
9) Trucks R’ Us has a market capitalization of $142 billion, $78 billion in BB rated debt, and $10 billion in
cash. If Trucks R’ Us’ equity beta is 1.68, then their underlying asset beta is closest to:
A) 1.00
B) 1.20
C) 1.32
D) 1.48
10) Luther Industries has a market capitalization of $23 billion, no debt, and $4 billion in cash. If
Luther’s estimated equity beta is 1.32, then the beta of Luther’s underlying business enterprise is closest
to:
A) 1.09
B) 1.32
C) 1.48
D) 1.60