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Site Title: Fundamentals of Financial Management, thirteenth edition

Book Title: Fundamentals of Financial Management, thirteenth edition

Book Author:

Van Horne/Wachowicz

Location on Site:

Student Resources > Chapter 5 > Multiple choice questions

Date/Time Submitted:

December 17, 2012 at 6:05 PM (UTC/GMT)

Summary of Results

14% Correct of 22 Scored items:

3 Correct:  14%

19 Incorrect:  86%

More information about scoring

1. The firm of Sun and Moon purchased a share of Acme.com common stock exactly one year ago for $45. During the past year the common stock paid an annual dividend of $2.40. The firm sold the security today for $85. What is the rate of return the firm has earned?

Your Answer:

194.2%

Correct Answer:

94.2%

  Return is over the two-year period and includes both dividends and capital gains. Return = [($2.40) + ($85 - $45)] / $45 = 94.2%

2. A set of possible values that a random variable can assume and their associated probabilities of occurrence are referred to as __________.

Your Answer:

the expected return

Correct Answer:

probability distribution

  The expected return is the weighted average of possible returns, with the weights being the probabilities of occurrence.

3. A statistical measure of the variability of a distribution around its mean is referred to as __________.

Your Answer:

the standard deviation

4. The ratio of the standard deviation of a distribution to the mean of that distribution is referred to as __________.

Your Answer:

a probability distribution

Correct Answer:

coefficient of variation

  A probability distribution is a set of possible values that a random variable can assume and their associated probabilities of occurrence.

5. The weighted average of possible returns, with the weights being the probabilities of occurrence is referred to as __________.

Your Answer:

the standard deviation

Correct Answer:

the expected return

  The standard deviation is a statistical measure of the variability of a distribution around its mean. It is the square root of the variance.

6. Clive Rodney Megabucks offers your friend, Melanie, an interesting gamble involving giving her the choice of the contents in one of two sealed, identical-looking boxes. One box has $20,000 in cash and the second has nothing inside. There is an equal probability that the chosen box contains cash versus nothing. Melanie states that she would not call off the gamble if you offered her a certain $10,999 instead of her choice of box. However, she would be indifferent if $11,000 was offered in place of the risky gamble; and she would definitely take $11,001 to call off the gamble. We would describe Melanie as __________ in this instance.

Your Answer:

being risk indifferent

Correct Answer:

having a risk preference

  Melanie would have had to tell us that she was indifferent at a guarantee of $10,000. Thus the expected value = the certainty equivalent.

7. Clive Rodney Megabucks offers your friend, Yunyoung, an interesting gamble involving giving her the choice of the contents in one of two sealed,

identical-looking boxes. One box has $20,000 in cash and the second has nothing inside. There is an equal probability that the chosen box contains cash versus nothing. Yunyoung states that she would not call off the gamble if you offered her a certain $4,999 instead of her choice of box. However, she would be indifferent if $5,000 was offered in place of the risky gamble; and she would definitely take $5,001 to call off the gamble. We would describe Yunyoung as __________ in this instance.

Your Answer:

having a risk preference

Correct Answer:

being risk averse

  Yunyoung would have had to tell us that a minimum guarantee exceeding $10,000 would be necessary to call off the gamble. Thus the expected value < the certainty equivalent.

8. Which of the following statements regarding covariance is correct?

Your Answer:

Covariance, because it involves a squared value, must always be a positive number (or zero).

Correct Answer:

Covariances can take on positive, negative, or zero values.

  Covariance can take on any positive, negative, or zero value.

9. Which of the following portfolio statistics statements is correct?

Your Answer:

A portfolio's standard deviation of return is a simple weighted average of individual security return standard deviations.

Correct Answer:

A portfolio's expected return is a simple weighted average of expected returns of the individual securities comprising the portfolio.

  A portfolio's standard deviation of return involves covariances and nothing about it is "simple."

10.

Total portfolio risk is __________.

Your Answer:

equal to systematic risk plus unavoidable risk

Correct Answer:

equal to systematic risk plus diversifiable risk

  Systematic risk is just another way of saying unavoidable risk

11.

__________ is the variability of return on stocks or portfolios not explained by general market movements. It is avoidable through diversification.

Your Answer:

Standard deviation.

Correct Answer:

Unsystematic risk

  Unsystematic risk is the diversifiable portion of total risk and not a measure of total risk like standard deviation.

12.

__________ is the variability of return on stocks or portfolios associated with changes in return on the market as a whole.

Your Answer:

Unsystematic risk

Correct Answer:

Systematic risk

  Unsystematic risk can be avoided through diversification; while systematic risk cannot be completely avoided and is associated with changes in return on the market as a whole.

13.

Which of the following indexes would be most the appropriate proxy to measure the return of the market portfolio in the CAPM?

Your Answer:

Dow Jones Industrial Index.

Correct Answer:

Standard & Poor's 500.

  A narrow, 30-stock index like the Dow Jones Industrial Index is not as good a proxy for the market as is the more broadly based S&P 500 Index.

14.

The __________ describes the linear relationship between expected rates of return for individual securities (or portfolios) and __________.

Your Answer:

security market line; standard deviation

Correct Answer:

security market line; beta

  Change standard deviation to beta and you've got it.

15.

The __________ describes the relationship between an individual security's returns and returns on the market portfolio. The slope of this line is __________.

Your Answer:

characteristic line; beta

16.

Which of the following items describes an index measure of systematic risk?

Your Answer:

Standard deviation.

Correct Answer:

Beta.

  The standard deviation is a measure of total risk.

17.

Which of the following items is a model that describes the relationship between risk and expected return (in this model the expected return is equal to the risk-free return plus a premium based on the systematic risk of the security)?

Your Answer:

Capital asset pricing model.

18.

What is the beta for an average risk security? What is the beta for a Treasury bill? 

Your Answer:

0; 1.

Correct Answer:

1; 0.

  The beta for an average risk security is 1; while a T-bill is considered risk-free with a beta of 0.

19.

Assume that a firm's common stock can be valued using the constant dividend growth model. As an analyst you expect that the return on the market will be 15% and the risk-free rate is 7%. You have estimated that the dividend next period will be $1.50, the firm will grow at a constant 6%, and the firm beta is 0.50. The common stock is currently selling for $30.00 in the market place. Which of the following statements is correct?

Your Answer:

The firm's stock is under priced.

Correct Answer:

The firm's stock is fairly priced.

  The firm's stock is not under priced. The required rate of return based on the CAPM is 11% = .07 + 0.50(.15 - .07). Using the constant dividend growth model, the value equals D1/(k - g) = $1.50/(.11 - .06) = $30. Since the intrinsic value equals the market price, the security is fairly priced.

20.

Which form of market efficiency states that current security prices fully reflect all information, both public and private?

Your Answer:

Semi-strong.

Correct Answer:

Strong.

  This form states that current prices fully reflect all publicly available information.

21.

Which form of market efficiency states that current prices fully reflect the historical sequence of prices?

Your Answer:

Semi-strong.

Correct Answer:

Weak.

  This form states that current prices fully reflect all publicly available information.

22.

Which form of market efficiency states that current prices fully reflect all publicly available information?

Your Answer:

Strong.

Correct Answer:

Semi-strong.

  This form states that current security prices fully reflect all information, both public and private.

1.

The return on common stocks is a combination of income paid to the stockholder plus any appreciation in stock price.

Your Answer:

False

Correct Answer:

True

  There are only two methods of receiving cash flows, and hence returns, as an owner of common stock. These are via dividends and the appreciation in the share price.

2.

As long as the correlation coefficient between two securities is less than 1.0, the standard deviation of a portfolio made up of these two securities will be less than the weighted average of the two individual standard deviations.

Your Answer:

True

3.

Investors can expect to be compensated with higher returns for bearing avoidable or unsystematic risk.

Your Answer:

False

4.

The "risk-free rate" is usually represented by the yield on short-term U.S. Treasury securities.

Your Answer:

False

Correct Answer:

True

  A short-term U.S. Treasury security is considered risk-free.

5.

The CAPM is a multifactor model.

Your Answer:

True

Correct Answer:

False

  The CAPM is a single-factor model.