Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 29: Basic Financial Tools: A review
1. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
a.
True
b.
False
ANSWER:
False
2. Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven
amounts.
a.
True
b.
False
ANSWER:
True
3. If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the
future value of the same series.
a.
True
b.
False
ANSWER:
False
4. Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present
value.
a.
True
b.
False
ANSWER:
False
5. If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.
a.
True
b.
False
ANSWER:
True
6. A "growing annuity" is a cash flow stream that grows at a constant rate for a specified number of periods.
a.
True
b.
False
ANSWER:
True
7. A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells initially) at par. These bonds
provide compensation to investors in the form of capital appreciation.
a.
True
b.
False
ANSWER:
False
8. The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a
profit, may be estimated by determining future cash flows and then discounting them back to the present.
a.
True
b.
False
ANSWER:
True
9. For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures.
a.
True
b.
False
ANSWER:
True
10. A bond that had a 20-year original maturity with 1 year left to maturity has more interest rate price risk than a 10-year
original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates,
and they cannot be called.)
a.
True
b.
False
ANSWER:
False
Copyright Cengage Learning. Powered by Cognero.
Page 5
11. Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally
be subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.
a.
True
b.
False
ANSWER:
False
12. The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as
measured by its standard deviation.
a.
True
b.
False
ANSWER:
False
13. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is
a standardized measure of the risk per unit of expected return.
a.
True
Chapter 29: Basic Financial Tools: A review
b.
False
ANSWER:
True
14. When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of
correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the
portfolio's risk.
a.
True
b.
False
ANSWER:
True
15. Diversification will normally reduce the riskiness of a portfolio of stocks.
a.
True
b.
False
ANSWER:
True
Copyright Cengage Learning. Powered by Cognero.
Page 7
16. An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the
portfolio in which the stock is held.
a.
True
b.
False
ANSWER:
False
17. Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of
how much those actions would increase the firm's expected rate of return.
a.
True
b.
False
ANSWER:
False
18. One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering
Chapter 29: Basic Financial Tools: A review
both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of
the asset held in isolation is not relevant under the CAPM.
a.
True
b.
False
ANSWER:
True
19. According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of
individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-
diversified portfolio.
a.
True
b.
False
ANSWER:
True
20. According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value
of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash
flows during the subsequent constant growth period.
a.
True
b.
False
ANSWER:
True
21. The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum
investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date.
a.
True
b.
False
ANSWER:
False
22. Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security
B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than
twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)
a.
True
b.
False
ANSWER:
False
23. The present value of a future sum decreases as either the discount rate or the number of periods per year increases,
other things held constant.
a.
True
b.
False
ANSWER:
True
24. All other things held constant, the present value of a given annual annuity decreases as the number of periods per year
increases.
a.
True
b.
False
ANSWER:
True
25. If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the
periodic rate by the number of periods per year.
a.
True
b.
False
ANSWER:
False
26. As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the
nominal rate on the deposit (or loan).
a.
True
b.
False
ANSWER:
False
Copyright Cengage Learning. Powered by Cognero.
Page 12
27. When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the
early years, and the principal repayment's percentage increases in the loan's later years.
a.
True
b.
False
ANSWER:
True
28. The payment made each period on an amortized loan is constant, and it consists of some interest and some principal.
The closer we are to the end of the loan's life, the greater the percentage of the payment that will be a repayment of
principal.
a.
True
b.
False
ANSWER:
True
29. A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and
is not expected to default. The bond should sell at a premium if interest rates are below 10% and at a discount if interest
rates are greater than 10%.
a.
True
Chapter 29: Basic Financial Tools: A review
b.
False
ANSWER:
True
30. You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper
that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10
years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on
bonds with this risk is 12%.
a.
True
b.
False
ANSWER:
True
31. The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds,
other things held constant.
a.
True
b.
False
ANSWER:
True
32. Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return
from the expected return, it is always larger than its square root, its standard deviation.
a.
True
b.
False
ANSWER:
True
33. Because of differences in the expected returns on different investments, the standard deviation is not always an
adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows
investors to make better comparisons of investments' stand-alone risk.
a.
True
b.
False
ANSWER:
True
Copyright Cengage Learning. Powered by Cognero.
Page 15
34. A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.
a.
True
b.
False
ANSWER:
False
35. A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who
holds a well-diversified portfolio.
a.
True
b.
False
ANSWER:
False
36. If the returns of two firms are negatively correlated, then one of them must have a negative beta.
a.
True
b.
False
Chapter 29: Basic Financial Tools: A review
ANSWER:
True
37. It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is
negative.
a.
True
b.
False
ANSWER:
True
38. Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would
expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.
a.
True
b.
False
ANSWER:
True
39. Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion
to its market value. Because of its diversification, Portfolio B will by definition be riskless.
a.
True
b.
False
ANSWER:
False
40. A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is
this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
a.
True
b.
False
ANSWER:
False
42. If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in
owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.
a.
True
b.
False
ANSWER:
False
43. The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because
betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This
is one of the strengths of the CAPM.
a.
True
b.
False
ANSWER:
False
44. Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If
its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to
calculate the firm's required rate of return.
a.
True
b.
False
ANSWER:
False
45. Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will
likely have an impact on the stock's price, other things held constant.
a.
True
b.
False
ANSWER:
True
Copyright Cengage Learning. Powered by Cognero.
Page 20
46. The slope of the SML is determined by the value of beta.
a.
True
b.
False
ANSWER:
False
47. If you plotted the returns of a company against those of the market and found that the slope of your line was negative,
the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-
diversified investor, assuming that the observed relationship is expected to continue in the future.
a.
True
b.
False
ANSWER:
True
48. If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression
line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-
free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.
a.
True
b.
False
ANSWER:
False
