Principle of Finance II 1-10 Questions

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1.  A firm has a $40 million capital budget limit. Five high IRR projects of about equal size are available that have initial investments totaling $30M. A sixth project has an IRR slightly lower than those of the first five, but requires a $16M investment. Several smaller projects are available with much lower IRR's. Discuss which projects should be done using capital rationing thinking.

2.  When retained earnings are exhausted, the MCC breaks upward. What happens if the firm continues to raise capital after that? Does the MCC remain flat or move further upward? In either case, why?

3.  Describe the difference between fixed and floating exchange rate systems.

Finance Mid-Term Exam Review

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Mid-Term Exam Review

Choose the BEST answer to each of the following questions.

1.     According to the efficient market hypothesis, financial markets fluctuate daily because they:

        a.     are inefficient.

        b.     slowly react to new information.

        c.     are continually reacting to new information.

        d.    offer tremendous arbitrage opportunities.

        e.     only reflect historical information.

Efficient market is defined as a market in which any relevant information is immediately impounded in asset prices

2.   According to the efficient capital market (ECM) theory, studying historical prices in order to identify mispriced stocks will work in __________________.

        a.     inefficient markets

        b.     weak form efficient markets

        c.     semistrong form efficient markets

        d.     strong form efficient markets

        e.     both semistrong and strong form efficient markets

Strong-form efficiency:  asset prices should reflect all private and public information. Extreme profit opportunities would exist for anyone that could persistently and successfully exploit publicly available information, hence the intense competition among investors should largely winnow away the mispriced stocks.

3.    Financial managers can create value through financing decisions that:

        a.      reduce costs or increase subsidies.

        b.     increase the product prices.

        c.      increase accounting earnings, even if they artificial.

        d.     time financial markets.

        e.      all of the above.

All of the above can impact expected cash flows

Finance

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1. (TCO 8) The historical returns on large-company stocks, as reported by Ibbotson and Sinquefield, are based on: (Points: 3)
       the largest 20 percent of the stocks traded on the NYSE.
       the stocks of the largest 10 percent of the publicly traded firms in the U.S.
       all of the stocks listed on the NYSE.
       the stocks of the 500 companies included in the S&P 500 index.


2. (TCO 8) Which of the following is true regarding the efficient market hypothesis? (Points: 3)
       It argues that efficient markets are not volatile throughout a trading day.
       It suggests that an efficient market can only consider historical information when determining current security prices.
       It proves that market inefficiencies do not exist in either the short-run or the long-run.
       It implies that all investments in an efficient market have a net present value of zero.


3. (TCO 8) Which of the following statements is false regarding systematic risk? Select all that apply: (Points: 4)
       is always diversifiable
       is the total risk associated with surprise events
       affects only a specific project or firm
       is measured by standard deviation


4. (TCO 8) Assume a project that has the following returns for years 1 to 5: 15%, 4%, -13%, 34%, and 17%. What is the approximate expected return of this investment? (Points: 3)
       11%
       17%
       16.60%
       10%


5. (TCO 8) Assume you are considering investing in two stocks, A & B. Stock A has an expected return of 16% and Stock B has an expected return of 9.5%. Your goal is to create a two-security portfolio that will have an expected return of 12%. If you have $250,000 to invest today, approximately how much would you invest in Stock B? (Points: 3)
       $96,000
       $150,000
       $175,000
      

More than $200,000

6. (TCO 8) For this exercise, use the information provided for Problem 30 of Chapter 11 (page 375 of your textbook). Assume that the probability of the state of the economy has changed as follows:

The probability of a recession has increased to 30% and the probability for a normal state of economy is now 40%. The market risk premium has increased by 1% as well. What is the beta and standard deviation of Stock I? (Points: 3)
       1.2 and 24%
       0.6 and 12%
       1.2 and 12.5%
       Cannot be determined with the information given 


7. (TCO 8) For this exercise, use the information provided for Problem 30 of Chapter 11 (page 375 of your textbook). Assume that the probability of the state of the economy has changed as follows:

The probability of a recession has increased to 30% and the probability for a normal state of economy is now 40%. The market risk premium has increased by 1% as well. Which statement is true? Select all that apply: (Points: 4)
       Stock II has more risk than Stock I
       Stock II has less systematic risk than Stock I

       Stock I has a higher risk premium than Stock II
       Stock I has a greater expected return than Stock II


8. (TCO 8) Which statements are true regarding risk? Select all that apply: (Points: 4)
       The expected return is usually the same as the actual return
       A key to assessing risk is determining how much risk an investment adds to a portfolio
       Risks can always be decreased or mitigated by the financial manager
       The higher the risk, the higher the return investors require for the investment


9. (TCO 8) What is systematic risk? Provide two or three examples. How can you diversify it? (Points: 3)