Mock Exam 3 Fall 2024 1 Which statements below is correct about financial asset returns a On average the return of small company stocks is higher than that of Treasury bills b Everyone should hold stocks instead of bonds because in the long run expected returns of c In the long run stocks have lower average returns than Treasury bills d A higher inflation expectation increases the present value of stocks but decreases the stocks are higher value of bonds 2 Over the last 100 years the average return on U S Treasury bills was 3 4 percent the average return on large stocks was 12 0 percent and on small stocks it was 16 6 percent What is the risk premium on large stocks and on small stocks over the last 100 years a 4 4 percent 3 4 percent b 8 6 percent 13 2 percent c 8 6 percent 3 4 percent d 8 6 percent 16 6 percent e 12 0 percent 16 6 percent 3 You invest in a portfolio that has an expected return of 15 percent The portfolio consists solely of two assets a stock of Wonka Industries with expected return of 12 percent and a T bill with an expected return of 2 percent What is the portfolio weight in the risk free asset a 130 percent b 30 percent c 30 percent d 100 percent e 130 percent 4 Which statement below about beta of a company s stock is wrong a Most stock betas are between 0 and 2 b The average beta is about 1 c In financial crises we expect high beta stocks to drop more d Beta cannot be negative 5 There are three possible states in the future a boom a recession and a normal economy The probability of a boom is 40 percent while the probability of a recession is 10 percent The common stock of Pure Oil Co is expected to lose 8 percent in a recession to lose 2 percent in a normal economy and gain 20 percent in a booming economy What is the expected rate of return on this stock a 10 2 percent b 9 5 percent c 8 7 percent d 6 2 percent e 5 5 percent 6 Which statement about risk return relationship is true about market efficiency a There is a positive relationship between expected return on an asset and the amount of idiosyncratic risk associated with that asset b Stock prices can be predicted by historical prices c You cannot predict future prices on a stock using public information d Institutions or individuals can still beat the market 7 Which one of the following should earn the highest risk premium based on CAPM a Portfolio with a beta of 1 64 b Diversified portfolio with returns similar to the overall market c Stock with a beta of 0 5 d Stock with a beta of 1 75 e U S Treasury bill 8 You have a portfolio that is invested 35 percent in Stock K 25 percent in Stock J and the remainder in Stock M The beta of Stock K is 0 85 and the beta of Stock J is 1 23 The beta of your portfolio is 1 35 What is the beta of the Stock M a 1 26 b 1 42 c 1 54 d 1 86 e 1 98 9 Consider two stocks A and B Stock A is fairly priced according to CAPM and its expected return is equal to 10 percent and its beta is equal to 0 8 The beta of stock B is equal to 1 6 What should be the expected return on stock B for it to be fairly priced The risk free rate is equal to 4 percent a 10 percent b 12 percent c 14 percent d 16 percent e 18 percent 10 Gekko Co stock has a beta of 1 5 and it has an expected return of 16 percent Assume the market rate of return is 9 5 percent and the risk free rate of return is 3 5 percent This stock a is underpriced b is correctly priced c is overpriced 11 Cooper Co has a beta of 1 27 The return on the U S Treasury bill is 3 2 percent and the market risk premium is 6 1 percent What is the cost of equity a 6 10 percent b 8 30 percent c 9 06 percent d 10 95 percent e 12 25 percent 12 Globex Corporation has a capital structure of 23 percent common stock 10 percent preferred stock and the rest is debt Its cost of common equity is 12 1 percent the cost of preferred equity is 9 6 percent and the after tax cost of debt is 5 5 percent where the corporate tax rate is 21 What is the company s WACC a 6 65 percent b 7 43 percent c 8 43 percent d 9 62 percent e 10 62 percent 13 Stark Industries has a bond issue outstanding with a total face value of 500 000 which is selling for 97 percent of par The firm also has 300 000 shares of common stock outstanding at a market price of 15 00 a share The cost of equity is 14 percent while the cost of debt is 6 8 percent and the corporate tax rate is 21 percent What is the weighted average cost of capital a 6 80 percent b 11 16 percent c 13 14 percent d 14 00 percent e 13 16 percent f 13 30 percent 14 The Flavorful Teas Co has a beta of 1 05 and a cost of equity of 11 3 percent The company is all equity financed What discount rate should the firm assign to a new project that has a beta of 1 31 if the risk free rate of return is 2 percent a 9 65 percent b 12 45 percent c 13 60 percent d 15 04 percent e 17 65 percent 15 Which of the following statements about portfolio is wrong a Portfolio return is the weighted average of the individual asset returns b Portfolio expected return is sum of the individual asset expected returns c If you have 1000 and invest 200 in Apple Inc stock then the portfolio share of Apple stock is 20 d Given the individual asset returns in each state and portfolio weights we can calculate the portfolio expected return and variance 16 The dividend yield on Metals Corporation common stock is 3 2 percent The company just paid a 1 50 annual dividend and announced plans to pay 1 60 next year The dividend growth rate is expected to remain constant at the current level What is the cost of equity of Metals Corporation using the dividend growth model DGM a 9 87 b 3 20 c 16 00 d 7 51 e 11 01 17 When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project the manager is …