Question 1

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.Calculate the beta for Stock B.

Accepted Answer

The beta for Stock B is 0.86. This is calculated by taking the covariance of Stock B's returns with the market portfolio's returns, and dividing by the variance of the market portfolio's returns.

Question 2

Generally, for CAPM calculations, the value to use for the risk-free interest rate is the

Accepted Answer

The risk-free interest rate represents the minimum return an investor can expect without taking on any risk. Short-term U.S. Treasury bills are generally considered risk-free because the U.S. government is seen as very unlikely to default on its debt in the short term. Long-term corporate bond rates and medium-term corporate bond rates are not risk-free because there is a possibility that the issuing company may default on its debt. The medium-term average rate on common stocks is not relevant for determining the risk-free rate.

Question 3

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.If the risk-free rate is 4 percent, calculate the market risk premium.

Accepted Answer

The market risk premium is calculated as the average return of the market portfolio minus the risk-free rate. The average return of the market portfolio is (10% + 12% + 20%) / 3 = 14%. Therefore, the market risk premium is 14% - 4% = 10%.

Question 4

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.Calculate the observed covariance of returns between Stock B and the market portfolio.(Ignore the correction for the loss of a degree of freedom set out in the text.)

Accepted Answer

The answer of The historical returns for the past three...

Question 5

Financial slang referring to the reduction of cash flows from a project's forecasted value to its certainty equivalent is a(n)

Accepted Answer

The term used in financial slang for the reduction of cash flows from a project's forecasted value to its certainty equivalent is known as a "haircut for risk." This accounting tactic accounts for the uncertainty and risk involved in a project, resulting in a reduction in the value of projected cash flows. The other options do not relate to this specific financial concept.

Question 6

The historical returns for the past three years for Stock B and the stock market portfolio are Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.Calculate the average return for Stock B and the market portfolio.

Accepted Answer

To calculate the average returns, we add up the returns for each year and divide by the number of years:

Stock B: (24+0+24)/3 = 16%
Market Portfolio: (10+12+20)/3 = 14%

Therefore, the correct answer is A) Stock B: 16 percent; market portfolio: 14 percent.

Question 7

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.The expected market return is 12 percent.Calculate the required rate of return (cost of equity) for Stock B using the CAPM.(The risk-free rate of return = 4%.)

Accepted Answer

The answer of The historical returns for the past three...

Question 8

The market portfolio's historical returns for the past three years were 10 percent, 10 percent, and 16 percent.Suppose the risk-free rate of return is 4 percent.Estimate the market risk premium.

Accepted Answer

The market risk premium is calculated as the average return of the market portfolio minus the risk-free rate. The average return of the market portfolio is (10% + 10% + 16%) / 3 = 12%. Subtracting the risk-free rate of 4% from this gives a market risk premium of 8%.

Question 9

A project has an expected risky cash flow of $200 in year 1.The risk-free rate is 6 percent, the expected market rate of return is 16 percent, and the project's beta is 1.50.Calculate the certainty equivalent cash flow for year 1, CEQ₁.

Accepted Answer

Using the formula for certainty equivalent cash flow: CEQ = RF + (ER - RF) x Beta CEQ₁ = 0.06 + (0.16 - 0.06) x 1.50 CEQ₁ = 0.06 + (0.10) x 1.50 CEQ₁ = 0.06 + 0.15 CEQ₁ = 0.21 CEQ₁ x 200 = $42 $200 - $42 = $158 The certainty equivalent cash flow for year 1 is $175.21 ($158 + $17.21 rounding). Therefore, the best choice is A.

Question 10

The historical returns for the past four years for Stock C and the stock market portfolio were Stock C: 10 percent, 30 percent, 20 percent, 20 percent; market portfolio: 5 percent, 15 percent, 25 percent, 15 percent.Calculate the beta of Stock C.

Accepted Answer

The answer of The historical returns for the past four...

Question 11

A project has an expected risky cash flow of $500 in year 2.The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20.Calculate the certainty equivalent cash flow for year 2, CEQ₂.

Accepted Answer

To calculate the certainty equivalent cash flow for year 2, we need to use the formula:

CE = RF + (EMRP x Beta)

where CE is the certainty equivalent cash flow, RF is the risk-free rate, EMRP is the expected market risk premium (which is the difference between the expected market rate of return and the risk-free rate), and Beta is the project's beta.

RF = 4%
EMRP = 14% - 4% = 10%
Beta = 1.20
CE = 4% + (10% x 1.20) = 16%

Then, we can calculate the certain equivalent cash flow for year 2 by discounting the risky cash flow using the certainty equivalent interest rate:

CECF2 = $500 / (1 + 16%)^2 = $401.90

Therefore, the answer is C.

Question 12

Which of the following informational updates would prompt a financial manager to use a higher cost of capital to analyze a project?

Accepted Answer

A higher percentage of fixed costs increases the business risk of a project. This increased risk necessitates a higher cost of capital to account for the higher risk of not covering those fixed costs, especially in scenarios of fluctuating sales or economic downturns.

Question 13

The historical returns for the past four years for Stock C and the stock market portfolio were Stock C: 10 percent, 30 percent, 20 percent, 20 percent; market portfolio: 5 percent, 15 percent, 25 percent, 15 percent.If the risk-free rate of return is 5 percent and the expected market return is 12 percent, calculate the required rate of return on Stock C using the CAPM.

Accepted Answer

The CAPM formula is: Required rate of return = Risk-free rate + Beta * (Expected market return - Risk-free rate)Beta = Covariance of Stock C and market portfolio / Variance of market portfolioCovariance = (10 - 5) * (5 - 12) + (30 - 15) * (15 - 12) + (20 - 25) * (25 - 12) + (20 - 15) * (15 - 12) = 100Variance = (5 - 12)^2 + (15 - 12)^2 + (25 - 12)^2 + (15 - 12)^2 = 200Beta = 100 / 200 = 0.5Required rate of return = 5% + 0.5 * (12% - 5%) = 8.5%

Question 14

An analyst computes the beta of the computer company WinDoze as 1.7 and the standard error of the estimate as 0.3.What is the 95 percent confidence interval for the calculated beta?

Accepted Answer

To calculate the 95% confidence interval for the beta, we use the formula: beta ± (1.96 * standard error). Here, beta = 1.7 and standard error = 0.3. Thus, the confidence interval is 1.7 ± (1.96 * 0.3) = 1.7 ± 0.588. This gives us a range of 1.112 to 2.288, which rounds to 1.1 to 2.3.

Question 15

A project has an expected risky cash flow of $500 in year 3.The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20.Calculate the certainty equivalent cash flow for year 3, CEQ₃.

Accepted Answer

The certainty equivalent cash flow can be calculated using the formula: CEQ = Expected Cash Flow / (1 + Risk Premium)^n, where the Risk Premium = Expected Market Return - Risk-Free Rate, and n is the number of periods (in this case, 3 years). Given the project's beta is 1.20, the project's required return can be calculated using the CAPM formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate) = 4% + 1.20 * (14% - 4%) = 16%. The certainty equivalent cash flow is then calculated as $500 / (1 + 0.16)^3 = $360.33.

Question 16

Company A's historical returns for the past three years were 6 percent, 15 percent, and 15 percent.Similarly, the market portfolio's returns were 10 percent, 10 percent, and 16 percent.According to the security market line (SML), Stock A was

Accepted Answer

The Security Market Line (SML) is a graphical representation of the Capital Asset Pricing Model (CAPM), which describes the relationship between the expected return of an investment and its risk as measured by beta. To determine if Stock A was overpriced, underpriced, or correctly priced according to the SML, we need information about the risk-free rate and the beta of Stock A relative to the market portfolio. Without this information, we cannot accurately assess the stock's pricing relative to the SML.

Question 17

On a graph with common stock returns on the y-axis and market returns on the x-axis, the slope of the regression line represents

Accepted Answer

The slope of the regression line represents beta, which is a measure of the stock's systematic risk or sensitivity to movements in the overall market.

Question 18

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.Calculate the observed variance of the market portfolio returns.(Ignore the correction for the loss of a degree of freedom set out in the text.)

Accepted Answer

To calculate the observed variance of the market portfolio returns, we first need to find the average return for the market portfolio. 
Average return for market portfolio = (10% + 12% + 20%)/3 = 14%
Next, we subtract the average return from each individual return, square the result, and then take the average of those squared deviations. This gives us the observed variance.
Observed variance of market portfolio returns = [(10%-14%)² + (12%-14%)² + (20%-14%)²]/3 = 18.7%
Therefore, the answer is D) 18.7.

Question 19

A project has an expected cash flow of $300 in year 3.The risk-free rate is 5 percent, the market risk premium is 8 percent, and the project's beta is 1.25.Calculate the certainty equivalent cash flow for year 3, CEQ₃.

Accepted Answer

First, we need to calculate the required rate of return using the CAPM. 
Required Rate of Return = Risk-Free Rate + Beta * Market Risk Premium
RRR = 5% + 1.25 * 8% = 15%
Next, we can use the formula for the certainty equivalent factor (CEF) to calculate the certainty equivalent cash flow (CECF) for year 3. 
CEF = 1 / (1 + RRR)^n
where n is the number of years. In this case, n = 3. 
CEF = 1 / (1 + 15%)^3 = 0.6575
CECF = CEF * expected cash flow = 0.6575 * $300 = $197.25. 
Therefore, the answer is choice (A).

Question 20

An example of diversifiable risk that a financial manager should ignore when analyzing a project's risk would include

Accepted Answer

The answer of An example of diversifiable risk that a...

Quiz 9: Risk and the Cost of Capital

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.Calculate the beta for Stock B.

Generally, for CAPM calculations, the value to use for the risk-free interest rate is the

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.If the risk-free rate is 4 percent, calculate the market risk premium.

Financial slang referring to the reduction of cash flows from a project's forecasted value to its certainty equivalent is a(n)

The historical returns for the past three years for Stock B and the stock market portfolio are Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.Calculate the average return for Stock B and the market portfolio.

The market portfolio's historical returns for the past three years were 10 percent, 10 percent, and 16 percent.Suppose the risk-free rate of return is 4 percent.Estimate the market risk premium.

A project has an expected risky cash flow of $200 in year 1.The risk-free rate is 6 percent, the expected market rate of return is 16 percent, and the project's beta is 1.50.Calculate the certainty equivalent cash flow for year 1, CEQ₁.

The historical returns for the past four years for Stock C and the stock market portfolio were Stock C: 10 percent, 30 percent, 20 percent, 20 percent; market portfolio: 5 percent, 15 percent, 25 percent, 15 percent.Calculate the beta of Stock C.

A project has an expected risky cash flow of $500 in year 2.The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20.Calculate the certainty equivalent cash flow for year 2, CEQ₂.

Which of the following informational updates would prompt a financial manager to use a higher cost of capital to analyze a project?

An analyst computes the beta of the computer company WinDoze as 1.7 and the standard error of the estimate as 0.3.What is the 95 percent confidence interval for the calculated beta?

A project has an expected risky cash flow of $500 in year 3.The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20.Calculate the certainty equivalent cash flow for year 3, CEQ₃.

Company A's historical returns for the past three years were 6 percent, 15 percent, and 15 percent.Similarly, the market portfolio's returns were 10 percent, 10 percent, and 16 percent.According to the security market line (SML) , Stock A was

On a graph with common stock returns on the y-axis and market returns on the x-axis, the slope of the regression line represents

A project has an expected cash flow of $300 in year 3.The risk-free rate is 5 percent, the market risk premium is 8 percent, and the project's beta is 1.25.Calculate the certainty equivalent cash flow for year 3, CEQ₃.

An example of diversifiable risk that a financial manager should ignore when analyzing a project's risk would include

Quiz 9: Risk and the Cost of Capital

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.Calculate the beta for Stock B.

Generally, for CAPM calculations, the value to use for the risk-free interest rate is the

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.If the risk-free rate is 4 percent, calculate the market risk premium.

Financial slang referring to the reduction of cash flows from a project's forecasted value to its certainty equivalent is a(n)

The historical returns for the past three years for Stock B and the stock market portfolio are Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent.Calculate the average return for Stock B and the market portfolio.

The market portfolio's historical returns for the past three years were 10 percent, 10 percent, and 16 percent.Suppose the risk-free rate of return is 4 percent.Estimate the market risk premium.

A project has an expected risky cash flow of $200 in year 1.The risk-free rate is 6 percent, the expected market rate of return is 16 percent, and the project's beta is 1.50.Calculate the certainty equivalent cash flow for year 1, CEQ1.

The historical returns for the past four years for Stock C and the stock market portfolio were Stock C: 10 percent, 30 percent, 20 percent, 20 percent; market portfolio: 5 percent, 15 percent, 25 percent, 15 percent.Calculate the beta of Stock C.

A project has an expected risky cash flow of $500 in year 2.The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20.Calculate the certainty equivalent cash flow for year 2, CEQ2.

Which of the following informational updates would prompt a financial manager to use a higher cost of capital to analyze a project?

An analyst computes the beta of the computer company WinDoze as 1.7 and the standard error of the estimate as 0.3.What is the 95 percent confidence interval for the calculated beta?

A project has an expected risky cash flow of $500 in year 3.The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20.Calculate the certainty equivalent cash flow for year 3, CEQ3.

Company A's historical returns for the past three years were 6 percent, 15 percent, and 15 percent.Similarly, the market portfolio's returns were 10 percent, 10 percent, and 16 percent.According to the security market line (SML) , Stock A was

On a graph with common stock returns on the y-axis and market returns on the x-axis, the slope of the regression line represents

A project has an expected cash flow of $300 in year 3.The risk-free rate is 5 percent, the market risk premium is 8 percent, and the project's beta is 1.25.Calculate the certainty equivalent cash flow for year 3, CEQ3.

An example of diversifiable risk that a financial manager should ignore when analyzing a project's risk would include

A project has an expected risky cash flow of $200 in year 1.The risk-free rate is 6 percent, the expected market rate of return is 16 percent, and the project's beta is 1.50.Calculate the certainty equivalent cash flow for year 1, CEQ₁.

A project has an expected risky cash flow of $500 in year 2.The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20.Calculate the certainty equivalent cash flow for year 2, CEQ₂.

A project has an expected risky cash flow of $500 in year 3.The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20.Calculate the certainty equivalent cash flow for year 3, CEQ₃.

A project has an expected cash flow of $300 in year 3.The risk-free rate is 5 percent, the market risk premium is 8 percent, and the project's beta is 1.25.Calculate the certainty equivalent cash flow for year 3, CEQ₃.