1 in the capital asset pricing model the market risk

Question

1. In the Capital Asset Pricing Model, the market risk premium can be thought of as:

• the return investors expect to earn for each unit of risk as measured by beta.
• the risk premium that any asset must pay above the risk-free rate.
• the expected return on the market portfolio (or a broad market index).
• a measure of risk of an asset.

Question 2. Which of the following is true regarding market risk?

• It is measured by beta.
• It is also called nondiversifiable risk.
• It is also called systematic risk.
• all of the above

Question 3. Which of the following is beta is used for?

• estimating a regression line
• estimating a firm's total risk to be used in the WACC
• estimating a firm's market risk and used with the CAPM
• estimating the amount of leverage used by the firm

Question 4. Which of the following statements regarding business risk, financial risk, and investors' risk, is true?

• Business risk is very similar to the risk of bankruptcy and is closely linked to the amount of debt in a firm's financing mix.
• Financial risk is associated with the returns earned by equity investors.
• Business risk is often measured by the variability of earnings before depreciation and taxes and is closely associated with the risk inherent in the goods and services a business is selling.
• Investment risk is the uncertainty associated with a firm's investment projects. It can be thought of as the likelihood that the expected IRR or NPV from an investment project will not materialize.

Question 5. In the Capital Asset Pricing Model, the market risk premium is estimated over a long period of time because:

• more data is always better than less.
• a longer holding period gives a more reliable estimate because it is, in effect, a larger sample size.
• almost all investors hold stocks for many years, so it matches their investment horizon.
• historical returns are the best indicators of future returns.

Question 6. Suppose a zero-coupon bond is selling for $614.00 today. It promises to pay $1,000 in exactly 10 years with annual compounding. What is the firm's after-tax cost of debt if this is its sole debt outstanding (assuming the firm is in the 20% tax bracket)?

• 4%
• 5%
• 6%
• 7%

Question 7. Which of the following is true of flotation costs?

• They include expenses like investment banker fees and commissions.
• They include the underwriting spread.
• They tend to raise the cost of capital.
• all of the above

Question 8. The Hamada Equation allows the firm to:

• solve for a company's total risk.
• adjust the beta of a pure-play firm for its use of debt financing.
• estimate its asset beta.
• Both b and c are correct.

Question 9. 9. The discount rate used in project evaluation should:

• be based on the firm's overall risk.
• be based on each project's risk.
• be estimated using the WACC for all projects.
• All of the above are correct.

Question 10. Beta is estimated as the slope of a regression line fit to pairs of periodic returns, (rx, ry), where:

• r_x is the return for a market index such as the S&P 500 Index.
• r_x is the return for the stock being analyzed-for example, IBM's return if we are estimating IBM's beta.
• the slope measures the average return for the market portfolio for each percentage change in the value of the security of interest.
• r_y is the return for the market index such as the S&P 500 Index.