Third Year

Managerial Finance

Final Revision
Part 1
(Chapters 1&4&5&6)

April 2016

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Theoretical,
Practical,
T & F,
And
MCQ

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 Chapter 1
The Role and Environment of Managerial
Finance

1- The part of finance concerned with design and delivery of advice and
financial products to individuals, business, and government is called
A) Managerial Finance.
B) Financial Manager.
C) Financial Services.
D) none of the above.
Answer: C

2- Managerial finance
A) involves tasks such as budgeting, financial forecasting, cash
management, and funds procurement.
B) involves the design and delivery of advice and financial products.
C) recognizes funds on an accrual basis.
D) devotes the majority of its attention to the collection and presentation
of financial data.
Answer: A

3- Finance can be defined as

A) the system of debits and credits.
B) the science of the production, distribution, and consumption of wealth.
C) the art and science of managing money.
D) the art of merchandising products and services.
Answer: C

4- Financial service
A) is concerned with the duties of the financial manager.
B) involves the design and delivery of advice and financial products.
C) provides guidelines for the efficient operation of the business.
D) handles accounting activities related to data processing.
Answer: B

5- Career opportunities in financial services include all of the following

EXCEPT
A) investments.
B) real estate and insurance.

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C) capital expenditures management.
D) personal financial planning.
Answer: C

6- Which of the following is a career opportunity in managerial finance?

A) Investment.
B) Real Estate and Insurance.
C) Capital expenditures Management.
D) Personal Financial Planning.
Answer: C

7- The responsibility for managing day-to-day operations and carrying

out corporate policies belongs to the ________.
A) board of directors
B) chief executive officer
C) stockholders
D) creditors

8- In a corporation, the members of the board of directors are elected by

the
A) chief executive officer.
B) creditors.
C) stockholders.
D) employees.
Answer: C

9- ________ is concerned with the duties of the financial manager in the

business firm.
A) Financial Services
B) Financial Manager
C) Managerial Finance
D) None of the above
Answer: C

10- The treasurer is commonly responsible for

A) taxes.
B) data processing.

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C) making capital expenditures.
D) cost accounting.
Answer: C

11- The controller is commonly responsible for

A) managing cash.
B) financial accounting.
C) managing credit activities.
D) financial planning.
Answer: B

12- The accountantʹs primary function is

A) evaluating the financial statements.
B) making decisions based on financial data.
C) the collection and presentation of financial data.
D) planning cash flows.
Answer: C

13- The accountant recognizes revenues and expenses on

A) a cash basis.
B) a revenue basis.
C) an accrual basis.
D) an expense basis.
Answer: C

14- The financial manager recognizes revenues and expenses utilizing

A) the accrual method.
B) the actual inflows and outflows of cash.
C) the standardized, generally accepted, accounting principles.
D) the revenue method.
Answer: B

15- The financial manager is interested in the cash inflows and outflows
of the firm, rather than the accounting data, in order to ensure
A) profitability.
B) the ability to pay dividends.
C) the ability to acquire new assets.
D) solvency.
Answer: D

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16- The accountant may be responsible for any of the following EXCEPT
A) processing purchase orders and invoices.
B) ensuring accounts payable are paid on time.
C) preparing the monthly income statement.
D) analyzing the mix of current to fixed assets.
Answer: D

17- Economic theories that the financial manager must be able to utilize
for efficient business operations, include
A) supply-and-demand analysis.
B) marginal analysis.
C) profit-maximizing strategies.
D) price theory.
E) all of the above.

18- The primary economic principle used in managerial finance is

A) supply and demand.
B) the liquidity trap.
C) the crowding out effect.
D) marginal analysis.
Answer: D

19- Johnson, Inc. has just ended the calendar year making a sale in the
amount of $10,000 of merchandise purchased during the year at a total
cost of $7,000. Although the firm paid in full for the merchandise during
the year, it has yet to collect at year end from the customer. The net profit
and cash flow from this sale for the year are
A) $3,000 and $10,000, respectively.
B) $3,000 and -$7,000, respectively.
C) $7,000 and -$3,000, respectively.
D) $3,000 and $7,000, respectively.
Answer: B

20- A firm has just ended its calendar year making a sale in the amount of
$150,000 of merchandise purchased during the year at a total cost of
$112,500. Although the firm paid in full for the merchandise during the
year, it has yet to collect at year end from the customer. The net profit
and cash flow from this sale for the year are

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A) $0 and $150,000, respectively.
B) $37,500 and -$150,000, respectively.
C) $37,500 and -$112,500, respectively.
D) $150,000 and $112,500, respectively.
Answer: C

21- Marginal analysis states that financial decisions should be made and
actions taken only when
A) demand equals supply.
B) benefits equal costs.
C) added benefits exceed added costs.
D) added benefits are greater than zero.
Answer: C

22- The officer responsible for the firmʹs accounting activities, such as
corporate accounting, tax management, financial accounting, and cost
accounting is the
A) treasurer.
B) controller.
C) foreign exchange manager.
D) none of the above.
Answer: B

23- The key role of the financial manager is

A) decision making.
B) the presentation of financial statements.
C) the preparation of data for future evaluation.
D) the collection of financial data.
Answer: A

24- The key activities of the financial manager include all of the
following EXCEPT
A) making financing decisions.
B) financial analysis and planning.
C) managing financial accounting.
D) making investment decisions.
Answer: C

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25- Included in the primary activities of the financial manager are
A) financial analysis and planning.
B) making investment decisions.
C) making financing decisions.
D) analyzing and planning cash flows.
E) all of the above.
Answer: E

26- The financial manager may be responsible for any of the following
EXCEPT
A) monitoring of quarterly tax payments.
B) analyzing budget and performance reports.
C) determining whether to accept or reject a capital asset acquisition.
D) analyzing the effects of more debt on the firmʹs capital structure.
Answer: A

27- Making investment decisions includes all of the following EXCEPT

A) inventory.
B) fixed assets.
C) accounts receivable.
D) notes payable.
Answer: D

28- Making financing decisions includes all of the following EXCEPT

A) determining the appropriate mix of short-term and long-term
financing.
B) deciding which individual short-term sources are best at a given point
in time.
C) analyzing quarterly budget and performance reports.
D) deciding which individual long-term sources are best at a given point
in time.
Answer: C

29- The financial managerʹs financing decisions determine

A) both the mix and the type of assets found on the firmʹs balance sheet.
B) the most appropriate mix of short-term and long-term financing.
C) both the mix and the type of assets and liabilities found on the firmʹs
balance sheet.
D) the proportion of the firmʹs earnings to be paid as dividend.
Answer: B

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30- The primary goal of the financial manager is
A) minimizing risk.
B) maximizing profit.
C) maximizing wealth.
D) minimizing return.
Answer: C

Chapter 1
The Role and Environment of Managerial
Finance

1- A financial analyst is responsible for maintaining and

controlling the firm's daily cash balances. Frequently manages
the firm's short-term investments and coordinates short-term
borrowing and banking relationships.

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Answer: FALSE

Comment the financial analyst responsible for analyzing the

financial data in order to judge on the financial performance of
the firm. While the person who is responsible for maintaining
and controlling the firm's daily cash balances is the controller.

2- Finance is concerned with the process institutions, markets,

and instruments involved in the transfer of money among and
between individuals, businesses and government.

Answer: TRUE

Comment because finance is the art and science of managing

money, one of the major areas of finance is the financial
services; it is the area of finance concerned with the design and
delivery of advice and financial products to individuals,
businesses and government.

3- The sole proprietor has unlimited liability; his or her total

investment in the business, but not his or her personal assets,
can be taken to satisfy creditors.

Answer: FALSE

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Comment Sole proprietor has unlimited liability, which
means that the owners total wealth (personal assets) can be
taken to satisfy creditors.

4- Marginal analysis states that financial decisions should be

made and actions taken only when added benefits exceeds
added costs.

Answer: TRUE

Comment because in this case the difference between

marginal revenue and marginal cost will be positive, thus there
will be an economic value added which will maximize the value
of the firm and therefore the wealth of the owners.

5- The financial manager places primary emphasis on cash

flows, the inflow and outflow of cash.

Answer: TRUE

Comment because the main difference between accounting

and finance is that; finance rely on the cash basis while
accounting rely on the accrual basis of accounting which states
that revenues should be recognized at the time of sales and
expenses should be recognized once they incurred.

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6- The financial manager must look beyond financial
statements to obtain insight into developing or existing
problems since the accrual accounting data do not fully
describe the circumstances of a firm.

Answer: TRUE

Comment because accounting mainly concerned with the

presentation & collection of financial data, these financial data
alone cannot describe the performance of the firm for that
reason the financial manager should look beyond these
financial data through analyzing and evaluating these financial
statements in order to judge on the financial performance of
the firm (what problems currently or might be exist).

7- When considering each financial decision alternative or

possible action in terms of its impact on the share price of the
firm's stock, financial managers should accept only those
actions that are expected to increase the firm's profitability.

Answer: FALSE

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Comment financial managers should accept only those
actions that are expected to increase the wealth of the owners,
in other words those actions that are expected to increase the
share price of the firm. Through that the ultimate objective of
the firm (wealth maximization) will be achieved.

8- Financing decisions deal with the left-hand side of the

firm's balance sheet and involve the most appropriate mix of
current and fixed assets.

Answer: FALSE

Comment Investment decisions deal with the left-hand side

of the firm's balance sheet, while the financing decisions deals
with the right hand side of the balance sheet.

11- The likelihood that managers may place personal goals

ahead of corporate goals is called the agency problem.

Answer: TRUE

Comment this problem mainly occurs in corporations

because in corporations there is a separation between
ownership and management, owners are not the managers. For
that reason managers might place their personal goals ahead of
owner's (corporate) goals.

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12- Agents of corporate owners are themselves owners of the
firm and have been elected by all the corporate owners to
represent them in decision-making and management of the
firm.

Answer: FALSE

Comment Agents of corporate owners are the board of

directors, they are not the owners themselves, they are not the
stock holders, but the owners exercise their voting rights in the
general assembly to elect this board of directors (agents). From
this separation between ownership and management the
agency problem exists.

13- Market forces and incurring agency costs help to prevent

or minimize agency problems.

Answer: TRUE

Comment One market force is the major shareholders, they

can exercise their voting rights to hire and fire managers.
Agency costs include for example cost of monitoring
management behavior in addition to other forms of costs, so
both of them (market forces and agency costs) can be used in
order to minimize or prevent the agency problem.
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14- Primary and secondary markets are markets for short-
term and long-term securities, respectively.

Answer: FALSE

Comment Money markets and capital markets are markets

for short-term and long-term securities, respectively. Primary
market is the financial market in which securities are initially
issued while the secondary market is the financial market in
which pre-owned securities are traded.

15- A primary market is a financial market in which pre-owned

securities are traded.

Answer: FALSE

Comment the secondary market is the financial market in

which pre-owned securities are traded. While the primary
market is the financial market in which securities are initially
issued.

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Chapter 4
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 Risk & Return

1- If a personʹs required return does not change when risk increases, that
person is said to be
A) risk-seeking.
B) risk-indifferent.
C) risk-averse.
D) risk-aware.
Answer: B

2- If a personʹs required return decreases for an increase in risk, that

person is said to be
A) risk-seeking.
B) risk-indifferent.
C) risk-averse.
D) risk-aware.
Answer: A

3- ________ is the chance of loss or the variability of returns associated

with a given asset.
A) Return
B) Value
C) Risk
D) Probability
Answer: C

4- The ________ of an asset is the change in value plus any cash

distributions expressed as a percentage of the initial price or amount
invested.
A) return
B) value
C) risk
D) probability
Answer: A

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Risk aversion is the behavior exhibited by managers who require a (n)
________.
A) increase in return, for a given decrease in risk
B) increase in return, for a given increase in risk
C) decrease in return, for a given increase in risk
D) decrease in return, for a given decrease in risk
Answer: B

5- If a person requires greater return when risk increases, that person is

said to be
A) risk-seeking.
B) risk-indifferent.
C) risk-averse.
D) risk-aware.
Answer: C

6- Last year Mike bought 100 shares of Dallas Corporation common

stock for $53 per share.
During the year he received dividends of $1.45 per share. The stock is
currently selling for $60
per share. What rate of return did Mike earn over the year?
A) 11.7 percent.
B) 13.2 percent.
C) 14.1 percent.
D) 15.9 percent.
Answer: D

7- Perry purchased 100 shares of Ferro, Inc. common stock for $25 per
share one year ago. During the year, Ferro, Inc. paid cash dividends of $2
per share. The stock is currently selling for $30 per share. If Perry sells all
of his shares of Ferro, Inc. today, what rate of return would he realize?

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8- Tim purchased a bounce house one year ago for $6,500. During the
year it generated $4,000 in cash flow. If Time sells the bounce house
today, he could receive $6,100 for it. What would be his rate of return
under these conditions?

9- Asset A was purchased six months ago for $25,000 and has generated
$1,500 cash flow during that period. What is the assetʹs rate of return if it
can be sold for $26,750 today?

10- The ________ is the extent of an assetʹs risk. It is found by

subtracting the pessimistic outcome from the optimistic outcome.
A) return
B) standard deviation
C) probability distribution
D) range
Answer: D

11- Since for a given increase in risk, most managers require an increase
in return, they are
A) risk-seeking.
B) risk-indifferent.
C) risk-free.
D) risk-averse.
Answer: D

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12- Which asset would the risk-averse financial manager prefer? (See
below.)

A) Asset A.
B) Asset B.
C) Asset C.
D) Asset D.
Answer: D

13- The expected value and the standard deviation of returns for asset A
is (See below.)

A) 12 percent and 4 percent.

B) 12.7 percent and 2.3 percent.
C) 12.7 percent and 4 percent.
D) 12 percent and 2.3 percent.
Answer: B

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14- The ________ the coefficient of variation, the ________ the risk.
A) lower; lower
B) higher; lower
C) lower; higher
D) more stable; higher
Answer: A

15- Given the following expected returns and standard deviations of

assets B, M, Q, and D, which asset should the prudent financial manager
select?

A) Asset B
B) Asset M
C) Asset Q
D) Asset D
Answer: A

16- The expected value, standard deviation of returns, and coefficient of

variation for asset A are (See below.)
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A) 10 percent, 8 percent, and 1.25, respectively.
B) 9.33 percent, 8 percent, and 2.15, respectively.
C) 9.35 percent, 4.68 percent, and 2.00, respectively.
D) 9.35 percent, 2.76 percent, and 0.295, respectively.
Answer: D

17- What is the market risk premium if the risk free rate is 5 percent and
the expected market return is given as follows?

A) 10.5%
B) 11.0%
C) 16.0%
D) 16.5%
Answer: B

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18- Nico bought 100 shares of Cisco Systems stock for $24.00 per share
on January 1, 2002. He received a dividend of $2.00 per share at the end
of 2002 and $3.00 per share at the end of 2003. At the end of 2004, Nico
collected a dividend of $4.00 per share and sold his stock for $18.00 per
share. What was Nicoʹs realized holding period return?
A) -12.5%
B) +12.5%
C) -16.7%
D) +16.7%
Answer: B

19- Nico bought 100 shares of Cisco Systems stock for $24.00 per share
on January 1, 2002. He received a dividend of $2.00 per share at the end
of 2002 and $3.00 per share at the end of 2003. At the end of 2004, Nico
collected a dividend of $4.00 per share and sold his stock for $18.00 per
share. What was Nicoʹs realized holding period return? What was Nicoʹs
compound annual rate of return?
A) -12.5%; -4.4%
B) +12.5%; +4.4%
C) -16.7%; -4.4%
D) +16.7%; +4.4%
Answer: B

20- Assuming the following returns and corresponding probabilities for

asset A, compute its standard deviation and coefficient of variation.

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21- Champion Breweries must choose between two asset purchases. The
annual rate of return and related probabilities given below summarize the
firmʹs analysis.

For each asset, compute

(a) the expected rate of return.
(b) the standard deviation of the expected return.
(c) the coefficient of variation of the return.
(d) Which asset should Champion select?

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22- The College Copy Shop is in process of purchasing a high-tech
copier. In their search, they have gathered the following information
about two possible copiers A and B.

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(a) Compute expected rate of return for each copier.
(b) Compute variance and standard deviation of rate of return for each
copier.
(c) Which copier should they purchase?

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23- A collection of assets is called a(n)
A) grouping.
B) portfolio.
C) investment.
D) diversity.
Answer: B

24- An efficient portfolio is one that

A) maximizes risk for a given level of return.
B) maximizes return for a given level of risk.
C) minimizes return for a given level of risk.
D) maximizes return at all risk levels.
Answer: B

25- The ________ is a statistical measure of the relationship between

series of numbers.
A) coefficient of variation
B) standard deviation
C) correlation
D) probability
Answer: C

26- The goal of an efficient portfolio is to

A) maximize risk for a given level of return.
B) maximize risk in order to maximize profit.
C) minimize profit in order to minimize risk.
D) minimize risk for a given level of return.
Answer: D

27- Perfectly ________ correlated series move exactly together and have
a correlation coefficient of ________, while perfectly ________
correlated series move exactly in opposite directions and have a
correlation coefficient of ________.
A) negatively; -1; positively; +1
B) negatively; +1; positively; -1

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C) positively; -1; negatively; +1
D) positively; +1; negatively; -1
Answer: D

28- Combining negatively correlated assets having the same expected

return results in a portfolio with ________ level of expected return and
________ level of risk.
A) a higher; a lower
B) the same; a higher
C) the same; a lower
D) a lower; a higher
Answer: C

29- An investment advisor has recommended a $50,000 portfolio

containing assets R, J, and K; $25,000 will be invested in asset R, with an
expected annual return of 12 percent; $10,000 will be invested in asset J,
with an expected annual return of 18 percent; and $15,000 will be
invested in asset K, with an expected annual return of 8 percent. The
expected annual return of this portfolio is
A) 12.67%.
B) 12.00%.
C) 10.00%.
D) unable to be determined from the information provided.
Answer: B

30- Akai has a portfolio of three assets. Find the expected rate of return
for the portfolio assuming he invests 50 percent of its money in asset A
with 10 percent rate of return, 30 percent in asset B with a rate of return
of 20 percent, and the rest in asset C with 30 percent rate of return.

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31- Combining two negatively correlated assets to reduce risk is known
as
A) diversification.
B) valuation.
C) liquidation.
D) risk aversion.
Answer: A

32- In general, the lower (less positive and more negative) the correlation
between asset returns,
A) the less the potential diversification of risk.
B) the greater the potential diversification of risk.
C) the lower the potential profit.
D) the less the assets have to be monitored.
Answer: B

33- Combining two assets having perfectly negatively correlated returns

will result in the creation
of a portfolio with an overall risk that
A) remains unchanged.
B) decreases to a level below that of either asset.
C) increases to a level above that of either asset.
D) stabilizes to a level between the asset with the higher risk and the asset
with the lower risk.
Answer: B

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34- Combining two assets having perfectly positively correlated returns
will result in the creation of a portfolio with an overall risk that
A) remains unchanged.
B) decreases to a level below that of either asset.
C) increases to a level above that of either asset.
D) lies between the asset with the higher risk and the asset with the lower
risk.
Answer: D

35- Systematic risk is also referred to as

A) diversifiable risk.
B) economic risk.
C) nondiversifiable risk.
D) not relevant.
Answer: C

36- The purpose of adding an asset with a negative or low positive beta is
to
A) reduce profit.
B) reduce risk.
C) increase profit.
D) increase risk.
Answer: B

37- The beta of the market

A) is greater than 1.
B) is less than 1.
C) is 1.
D) cannot be determined.
Answer: C

38- Risk that affects all firms is called

A) total risk.
B) management risk.
C) nondiversifiable risk.
D) diversifiable risk.
Answer: C
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39- The relevant portion of an assetʹs risk attributable to market factors
that affect all firms is called
A) unsystematic risk.
B) diversifiable risk.
C) systematic risk.
D) none of the above.
Answer: C

40- ________ risk represents the portion of an assetʹs risk that can be
eliminated by combining assets with less than perfect positive correlation.
A) Diversifiable
B) Nondiversifiable
C) Systematic
D) Total
Answer: A

41- Unsystematic risk is not relevant, because

A) it does not change.
B) it can be eliminated through diversification.
C) it cannot be estimated.
D) it cannot be eliminated through diversification.
Answer: B

42- An investment banker has recommended a $100,000 portfolio

containing assets B, D, and F. $20,000 will be invested in asset B, with a
beta of 1.5; $50,000 will be invested in asset D, with a beta of 2.0; and
$30,000 will be invested in asset F, with a beta of 0.5. The beta of the
portfolio is
A) 1.25.
B) 1.33.
C) 1.45.
D) unable to be determined from the information provided.
Answer: C

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43- Given the information in Table 5.2, what is the expected annual
return of this portfolio?
A) 11.4%
B) 10.0%
C) 11.0%
D) 11.7%
Answer: C

44- The beta of the portfolio in Table 5.2, containing assets X, Y, and Z,
is
A) 1.5.
B) 2.4.
C) 1.6.
D) 2.0.
Answer: C

45- The beta of the portfolio in Table 5.2 indicates this portfolio
A) has more risk than the market.
B) has less risk than the market.
C) has an undetermined amount of risk compared to the market.
D) has the same risk as the market.
Answer: A

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46- As randomly selected securities are combined to create a portfolio,
the ________ risk of the portfolio decreases until 10 to 20 securities are
included. The portion of the risk eliminated is ________ risk, while that
remaining is ________ risk.
A) diversifiable; nondiversifiable; total
B) relevant; irrelevant; total
C) total; diversifiable; nondiversifiable
D) total; nondiversifiable; diversifiable
Answer: C

47- Nicole holds three stocks in her portfolio: A, B, and C. The portfolio
beta is 1.40. Stock A comprises 15 percent of the dollar value of her
holdings and has a beta of 1.0. If Nicole sells all of her investment in A
and invests the proceeds in the risk-free asset, her new portfolio beta will
be:
A) 0.60.
B) 0.88.
C) 1.00.
D) 1.25.
Answer: D

48- Nico owns 100 shares of stock X which has a price of $12 per share
and 200 shares of stock Y which has a price of $3 per share. What is the
proportion of Nicoʹs portfolio invested in stock
X?
A) 77%
B) 67%
C) 50%
D) 33%
Answer: B

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49- Which asset (X or Y) in Table 5.3 has the least total risk? Which has
the least systematic risk?
A) X; X.
B) X; Y.
C) Y; X.
D) Y; Y.
Answer: B

50- Using the data from Table 5.3, what is the systematic risk for a
portfolio with two -thirds of the funds invested in X and one-third
invested in Y?
A) 0.88
B) 1.17
C) 1.33
D) 1.67
Answer: C

51- Using the data from Table 5.3, what is the portfolio expected return
and the portfolio beta if you invest 35 percent in X, 45 percent in Y, and
20 percent in the risk -free asset?
A) 12.5%, 0.975
B) 12.5%, 1.975
C) 15.0%, 0.975
D) 15.0%, 1.975
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Answer: A

52- Using the data from Table 5.3, what is the portfolio expected return if
you invest 100 percent of your money in X, borrow an amount equal to
half of your own investment at the risk free rate and invest your
borrowings in asset X?
A) 15.0%
B) 22.5%
C) 25.0%
D) 27.5%
Answer: D

53- What is the expected return for asset X if it has a beta of 1.5, the
expected market return is 15 percent, and the expected risk-free rate is 5
percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 20.0%
Answer: D

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 Chapter 4
Risk and Return

1- For the risk-seeking manager, no change in return would be

required for an increase in risk.

Answer: FALSE

Comment risk-seeking managers can accept a lower level of

return for an increase in risk. They accept this lower level of
return because they are risky lovers.

2- The return on an asset is the change in its value plus any

cash distribution over a given period of time, expressed as a
percentage of its ending value.

Answer: FALSE

Comment The return on an asset is the change in its value

plus any cash distribution over a given period of time, divided
by the value of the asset at the beginning. This can be shown in
the following equation:

R = CF + Pt – Pt-1

Pt-1

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3- Investment A guarantees its holder $100 return.
Investment B earns $0 or $200 with equal chances (i.e., an
average of $100) over the same period. Both investments
have equal risk.

Answer: FALSE

Comment investment A is less risky than investment B, in

investment A there is no variability in return while in
investment B there is a variability in return, and as long as the
higher the variability the higher the risk so investment B is
more risky than investment A.

4- Financial risk is the chance that the firm will be unable to

cover its operating costs and is affected by a firm's revenue
stability and the structure of its operating costs (fixed vs.
variable).

Answer: FALSE

Comment This is the Business Risk.

5- The real utility of the coefficient of variation is in comparing

assets that have equal expected returns.

Answer: FALSE

Comment The real utility of the coefficient of variation is in

comparing assets that have different expected returns as in this
case the coefficient of variation will give us an additional
information about the real value of risk associated with each
asset.

37
6- The larger the difference between an asset's worst
outcome from its best outcome, the higher the risk of the
asset.

Answer: TRUE

Comment because this difference represent the range, which

reflect the variability of returns, so the higher the range the
higher the variability of returns and therefore the higher the
risk.

7- An approach for assessing risk that uses a number of

possible return estimates to obtain a sense of the variability
among outcomes is called sensitivity analysis.

Answer: TRUE

Comment because both sensitivity analysis and probability

distribution are two techniques used to assess the level of risk;
they provide only indication about the level of risk. Sensitivity
analysis refers to the range (difference between highest and
lowest possible outcomes) and the higher the range the higher
the variability of outcomes so the higher the level of risk.

38
8- The higher the coefficient of variation, the greater the risk
and therefore the higher the expected return.

Answer: TRUE

Comment coefficient of variation measure the risk

associated with 1% of return, so the higher the coefficient of
variation the higher the risk, and since the return is the price of
risk so the greater the risk the higher the expected return.

9- New investments must be considered in light of their

impact on the risk and return of the portfolio of assets
because the risk of any single proposed asset investment is
not independent of other assets.

Answer: TRUE

Comment because the portfolio risk mainly depends on the

degree of correlation that exists between the group of assets
from which the portfolio is formed, the higher the degree of
correlation the higher the level of risk and vice versa.

10- Two assets whose returns move in the same direction and
have a correlation coefficient of +1 are each very risky assets.

Answer: FALSE

Comment because there is no direct relationship between

the degree of correlation of the two assets and the risk of each
individual asset. However, there is a direct relationship
between the degree of correlation of the two assets and the

39
risk of the portfolio, the higher the degree of correlation the
higher the level of portfolio risk and vice versa.

11- The standard deviation of a portfolio is a function of the

standard deviations of the individual securities in the
portfolio, the proportion of the portfolio invested in those
securities, and the correlation between the returns of those
securities.

Answer: TRUE

Comment because the standard deviations of the individual

securities in the portfolio is not only the factor that affect the
portfolio risk, however the portfolio risk is a function of the
standard deviations of the individual securities in the portfolio,
the proportion of the portfolio invested in those securities, and
the degree of correlation between the returns of those
securities. This can be shown in the following equation:

12- Combining negatively correlated assets can reduce the

overall variability of returns.

Answer: TRUE

Comment because there is a positive relationship between

the degree of correlation and the overall variability of returns,
so the higher the degree of correlation the higher the risk
(variability of returns), and the lower the degree of correlation
the lower the risk (variability of returns).

40
13- Most investors are risk averse, since for a given increase in
return they require an increase in risk.

Answer: FALSE

Comment Most investors are risk averse, they demand (ask

for) more return to accept more risk.

14- In general, the lower the correlation between asset

returns, the greater the potential diversification of risk.

Answer: TRUE

Comment because there is a positive relationship between

the degree of correlation and the overall level of risk.

15- Even if assets are not negatively correlated, the lower the
positive correlation between them, the lower the resulting
risk.

Answer: TRUE

Comment because there is a positive relationship between

the degree of correlation and the overall level of risk.

16- A portfolio of two negatively correlated assets has less risk

than either of the individual assets.

41
Answer: TRUE

Comment because the degree of correlation between the

two assets from which the portfolio is formed is negative, so
the correlation coefficient will be negative, so the overall
portfolio risk will be lower than the risk of riskless asset. This
can be shown in the following equation; the last term will be
negative so the overall portfolio risk will be less than the
riskless asset.

17- Combining uncorrelated assets can reduce risk not as

effectively as combining negatively correlated assets, but
more effectively than combining positively correlated assets.

Answer: TRUE

Comment because there is a positive relationship between

the degree of correlation and the overall level of risk. A
correlation coefficient equal zero is better than a positive
correlation coefficient.

18- Assume your firm produces a good which has high sales
when the economy is expanding and low sales during a
recession. This firm's overall risk will be higher if it invests in
another product which is counter cyclical.

Answer: FALSE

Comment in case of investing in another product which is

counter cyclical the firm's overall risk will not be high as it
moves in the same direction with the market, in other words

42
beta of this firm equal 1 (as same as the market) so the firm's
level of risk will not increase.

19- The creation of a portfolio by combining two assets having

perfectly positively correlated returns cannot reduce the
portfolio's overall risk below the risk of the least risky asset.
On the other hand, a portfolio combining two assets with less
than perfectly positive correlation can reduce total risk to a
level below that of either of the components.

Answer: TRUE

Comment because there is a positive relationship between

the degree of correlation and the overall level of risk. positively
correlated is better than perfect positive, uncorrelated is better
than positively correlated, negatively correlated is better then
uncorrelated, perfect negative correlation is better than
negatively correlated.

20- Total security risk is the sum of a security's non

diversifiable, diversifiable, systematic, and unsystematic risk.
Answer: FALSE

Comment Total Risk = Systematic Risk + Unsystematic Risk

(Non diversifiable) + (diversifiable risk)

21- Beta coefficient is an index of the degree of movement of

an asset's return in response to a change in the risk-free asset.

Answer: FALSE
43
Comment Beta coefficient is an index of the degree of
movement of an asset's return in response to a change in the
market return, the higher the beta the higher the risk.

22- Unsystematic risk can be eliminated through

diversification.

Answer: TRUE

Comment Diversifiable risk can be eliminated through

diversification through constructing an efficient portfolio;
efficient portfolio is the portfolio that maximizes return for a
given level of risk or minimizes risk for a given level of return.

23- The beta of a portfolio is a function of the standard

deviations of the individual securities in the portfolio, the
proportion of the portfolio invested in those securities, and
the correlation between the returns of those securities.

Answer: FALSE

Comment The beta of a portfolio is a function of the beta of

each individual asset from which the portfolio is formed in
addition to the proportion of the portfolio invested in those
assets (securities). This can be shown in the following equation:

bp = (W1 X b1) + (W2 X b2) + ……….. + (Wn X bn)

24- The difference between the return on the market portfolio

of assets and the risk-free rate of return represents the
premium the investor must receive for taking the average

44
amount of risk associated with holding the market portfolio of
assets.

Answer: TRUE

Comment rj  RF [bj(rm  RF)], The difference between

the return on the market portfolio of assets and the risk-free
rate of return represents the market risk premium which is the
premium the investor must receive for taking the average
amount of risk associated with holding the market portfolio of
assets.

28- Longer-lived assets usually are more risky because it is

more difficult to accurately forecast cash flows that occur far
into the future.

Answer: TRUE

Comment Longer-lived assets are more risky than shorter-

term assets, in general there is a positive relationship between
the amount of time period and the level of risk the longer the
time period the higher the level of risk.

29- Fixed income securities such as bonds or preferred stocks,

usually have betas equal to zero.

Answer: TRUE

Comment because they are fixed income securities, their

holders will receive constant fixed payments periodically, there
is no variability in return exist, so their betas are supposed to
be equal to zero.

45
Chapter 5
46
 Interest Rate & Bond Valuation
1- The process that links risk and return in order to determine the worth of an
asset is termed
A) evaluation.
B) valuation.
C) discounting.
D) variable growth.
Answer: B

2- A type of long-term financing used by both corporations and government

entities is
A) common stock.
B) bonds.
C) preferred stock.
D) retained earnings.
Answer: B

3- Bonds are
A) a series of short-term debt instruments.
B) a form of equity financing that pays interest.
C) long-term debt instruments.
D) a hybrid form of financing used to raise large sums of money from a diverse
group of
lenders.
Answer: C

4- The less certain a cash flow, the ________ the risk, and the ________ the present
value of the
cash flow.
A) lower; higher
B) lower; lower
C) higher; lower
D) higher; higher
Answer: C

47
5- ________ of all future cash flows an asset is expected to provide over a relevant
time period is
the market value of the asset.
A) The future value
B) The present value
C) The stated value
D) The sum
Answer: B

6- The return expected from an asset is fully defined by its

A) risk and cash flow.
B) cash flow and timing.
C) discount rate.
D) beta.
Answer: B

7- The key inputs to the valuation process include

A) returns and risk.
B) cash flow, cash flow timing, and risk.
C) cash flows and discount rate.
D) returns, discount rate, and risk.
Answer: B

8- The ABC company has two bonds outstanding that are the same except for the
maturity date.
Bond D matures in 4 years, while Bond E matures in 7 years. If the required return
changes by
15 percent
A) Bond D will have a greater change in price.
B) Bond E will have a greater change in price.
C) the price of the bonds will be constant.
D) the price change for the bonds will be equal.
Answer: B

48
9- A firm has an issue of $1,000 par value bonds with a 12 percent stated interest
rate
outstanding. The issue pays interest annually and has 10 years remaining to its
maturity date.
If bonds of similar risk are currently earning 8 percent, the firmʹs bond will sell for
________
today.
A) $1,000
B) $805.20
C) $851.50
D) $1,268.20
Answer: D

10- When valuing a bond, the characteristics of the bond that remain fixed are all
of the following
EXCEPT the
A) coupon rate.
B) price.
C) face value.
D) interest payment.
Answer: B

11- A firm has an issue of $1,000 par value bonds with a 9 percent stated interest
rate outstanding.
The issue pays interest annually and has 20 years remaining to its maturity date.
If bonds of
similar risk are currently earning 11 percent, the firmʹs bond will sell for ________
today.
A) $1,000
B) $716.67
C) $840.67
D) $1,123.33
Answer: C

49
12- Hewitt Packing Company has an issue of $1,000 par value bonds with a 14
percent annual
coupon interest rate. The issue has ten years remaining to the maturity date.
Bonds of similar
risk are currently selling to yield a 12 percent rate of return. The current value of
each Hewitt
bond is ________.
A) $791.00
B) $1,000
C) $1,052.24
D) $1,113.00
Answer: D

13- Danno is trying to decide which of two bonds to buy. Bond H is a 10

percent coupon, 10 –year maturity, $1,000 par, January 1, 2000 issue
paying annual interest. Bond F is a 10 percent coupon, 10-year maturity,
$1,000 par, January 1, 2000 issue paying semiannual interest. The market
required return for each bond is 10 percent. When using present value to
determine the prices of the bonds, Danno will find that
A) there is no difference in price.
B) the price of F is greater than H.
C) the price of H is greater than F.
D) he needs more information before determining the prices.
Answer: A

14-What is the current price of a $1,000 par value bond maturing in 12

years with a coupon rate of 14 percent, paid semiannually, that has a
YTM of 13 percent?
A) $604
B) $1,090
C) $1,060
D) $1,073
Answer: C

50
15-Tangshan Coal, Inc. just issued a 10 percent, 25 -year bond with a
$1,000 par value that pays interest semiannually.
(a) How much can the investor expect in annual interest (in dollars)?
(b) How much can the investor expect in interest every six months (in
dollars)?
(c) How much can the investor expect in par value at the end of the 25th
year?
Answer: (a) $100
(b) $50
(c) $1,000

Chapter 5
Interest Rates and Bond Valuation

51
1- If the value of a bond, B0, is less than its par value, the bond
is selling at a discount.

Answer: TRUE

Comment because in this case the stated rate will be lower

than the market rate, so in order to compensate the
bondholders for this lower rate (compared to the market) the
bond should be sold at a discount (at a value lower than its par
value).

2- In a practical sense, the longer the term of a bond, the

greater the default risk associated with the bond.

Answer: TRUE

Comment because there is a positive relationship between

the term of the bond and the default risk, the longer the term
of the bond the higher the default risk.

3- If a bond's required return always equals its coupon

interest rate, bond's value will remain at par until it matures.

Answer: TRUE
Comment because there is a negative relationship between the
required rate of return and the bond vale, if the required rate of return
is lower than the coupon interest rate bond value will increase
(premium), if the required rate of return is higher than the coupon
interest rate bond value will decrease (discount). If both the required
rate of return and the coupon interest rate are equal bond value will
remains at its par.

52
4- The bond indenture reports on the risk characteristics of
the bond.

Answer: False

Comment the bond indenture is a legal document that

specifies both the rights of the bondholders and the duties of
the issuing corporation. There is no relationship between the
risk characteristics of the bond and the bond indenture.

5- Bond rating agencies provide investors a rating that reflects

the default risk of a bond issue.

Answer: TRUE

Comment because bond rating agencies judge on the

creditability of the borrowing company, so investors in advance
(before buying the bond) will know the level of default risk that
they will incurred. The higher the creditability the lower the
default risk of the bond and vice versa.

6- A call premium is the amount by which the call price

exceeds the market price of the bond.

Answer: FALSE

Comment a call premium is the amount by which a bond's

call price exceeds its par value.

53
7- Any action that increases the risk of an asset will also
increase that asset's required return.

Answer: TRUE

Comment because the return is the price of risk, the higher

the risk you will incurred the higher the return you will receive.

8- The length of the maturity on a bond offering affects its

cost. In general, the longer the maturity, the lower the cost.

Answer: FALSE

Comment the length of the maturity on a bond is one of the

factors that affect the bond value in addition to other factors
such as the size of offering, issuer risk, and coupon interest
rate. But in general, the longer the maturity, the higher the cost
(bond value) because there is a positive relationship between
the bond value and the time to maturity.

9- Bonds with short maturities will have less interest rate risk
than bonds with longer maturities and equal features.

Answer: TRUE

Comment because there is a positive relationship between

time to maturity and the level of interest rate risk associated
with the bond. Bonds with short term maturities will have less

54
interest rate risk while bonds with long term maturities will
have higher interest rate risk.

10- High-quality (high-rated) bonds provide lower returns

than lower-quality (low-rated) bonds.

Answer: TRUE

Comment because the return is the price of risk. High-quality

(high-rated) bonds are less risky so their return will be low,
while lower-quality (low-rated) bonds are more risky so their
return will be high.

55
 Chapter 6
Stock Valuation

1- You are planning to purchase the stock of Ted's Sheds

Inc. and you expect it to pay a dividend of $3 in 1 year, $4.25
in 2 years, and $6.00 in 3 years. You expect to sell the stock
for $100 in 3 years. If your required return for purchasing
the stock is 12 percent, how much would you pay for the
stock today?

Answer: $81.52

2- In response to the stock market's reaction to its dividend

policy, the Nicoʹs Toy Company has decided to increase its
dividend payment at a rate of 4 percent per year. The firm's
most recent dividend is $3.25 and the required rate of
interest is 9 percent. What is the maximum amount you
would be willing to pay for a share of the stock?

Answer: P = D1/(r - g) = 3.25(1 + 0.04)/(0.09 - 0.04) = $67.60

56
3- Miaʹs Doll Company has an outstanding preferred issue
of stock with a par value of $100 and an annual dividend of
10 percent (of par). Similar risk preferred stocks are
yielding an 11.5 percent annual rate of return.

(A) What is the current value of the outstanding preferred stock?

(B) What will happen to price as the risk-free rate increases?
Explain.

Answer:
(A) In evaluating preferred stock the zero growth model can be
used because preferred stock holders receive a constant fixed
amount of dividends periodically.

P0= $10/0.115 = $86.96

(B) As the risk-free rate increases, the required rate of return

will increase and the stock price will drop because there is a
negative relationship between the required rate of return and the
stock price.

4- Colin recently purchased a block of 100 shares of Hayley's

Optical common stock for $6,000. The stock is expected to
57
provide an annual cash flow of dividends of $400
indefinitely. Assuming a discount rate of 8% how does the
price Colin paid compare to the value of the stock?

Answer: The value of the stock is = $400 = $5,000

0.08
Mr. Arthur paid $1,000 more than the value of the stock.

5- The Erie Heating Company has been very successful in

the past four years. Over these years, it paid common stock
dividend of $4 in the first year, $4.20 in the second year,
$4.41 in the third year, and its most recent dividend was
$4.63. The company wishes to continue this dividend growth
indefinitely. What is the value of the company's stock if the
required rate of return is 12 percent?

6- Given the following table:

Year Dividends ($)

2003 2.89
2002 2.53
2001 2.22
2000 1.95
1999 1.71
1998 1.50

58
A) Calculate the growth rate of these dividends.
B) Calculate the estimated dividend for 2004.
C) Using the Gordon model, calculate the per share value of the
stock if the required return is assumed to be 17 percent.

Answer:
A) g = 14%
B) $3.29
C) $109.67

7- Nico Corporation expects to generate free-cash flows of

$200,000 per year for the next five years. Beyond that time,
free cash flows are expected to grow at a constant rate of 5
percent per year forever. If the firm's average cost of capital
is 15 percent, the market value of the firm's debt is $500,000,
and Nico has a half million shares of stock outstanding, what
is the value of Nicoʹs stock?
Answer: $2..43

8- BFG has current assets of $800,000, which can be

liquidated at 90 percent of book value. Total liabilities,
including preferred stock, equal $270,000. The firm has
15,000 shares of common stock outstanding. What is the
liquidation value per share of common stock?

Answer: $800,000(0.90) - $270,000

59
 15,000
= $30/share
9- Due to growing demand for computer software, the Perry
Company has had a very successful year and expects its
earnings per share to grow by 25 percent to reach $5.50 for
this year. Estimate the price of the companyʹs common stock
assuming the industryʹs price/earning ratio is 12.

Answer: P = (P/E)(E) = 12 × 5.50 = $66

10- Tangshan China's stock is currently selling for $160.00

per share and the firm's dividends are expected to grow at 5
percent indefinitely. In addition, Tangshan China's most
recent dividend was $5.50. If the expected risk free rate of
return is 3 percent, the expected market premium is 4
percent, and Tangshan has a beta of 1.2, determine whether
Tangshan's stock would be overvalued or undervalued and
why?

Answer: Undervalued

11- Tangshan China's stock is currently selling for $160.00

per share and the firm's dividends are expected to grow at 5
percent indefinitely. In addition, Tangshan China's most
recent dividend was $5.50. The expected risk free rate of
return is 3 percent, the expected market return is 8 percent,
and Tangshan has a beta of 1.20.

60
(A) What is the expected return based on the dividend valuation
model?
(B) What is the required return based on the CAPM?
(C) Would Tangshan China be a good investment at this time?
Explain

Answer:

(A) rs = [$5.50(1.05)]/$160.00 + 0.05 = 8.6%, solve the equation

of the constant growth model to the unknown variable which is
rs.

(B) rs = 0.03 + 1.2(0.08 - 0.03) = 9%

(C) The expected return is 8.6 percent but the required return is
9 percent. Based on this information, Tangshan would not be a
good investment at this time. Because the expected return is
lower than the required return (8.6% < 9%).

12- ________ are promised a fixed periodic dividend that must be paid
prior to paying any common stock dividends.
A) Preferred stockholders
B) Common stockholders
C) Bondholders
D) Creditors
Answer: A

13- An 8 percent preferred stock with a market price of $110 per share
and a $100 par value pays a cash dividend of ________.
A) $4.00

61
B) $8.00
C) $8.80
D) $80.00
Answer: B

14- The cost of preferred stock is

A) lower than the cost of long-term debt.
B) higher than the cost of common stock.
C) higher than the cost of long-term debt and lower than the cost of
common stock.
D) lower than the cost of convertible long-term debt and higher than the
cost of common stock.
Answer: C

15- All of the following are characteristics of preferred stock EXCEPT

A) it is often considered quasi-debt due to fixed payment obligation.
B) it has less restrictive covenants than debt.
C) it gives the holder voting rights which permit selection of the firmʹs
directors.
D) its holders have priority over common stockholders in the liquidation
of assets.
Answer: C

16- The ________ are sometimes referred to as the residual owners of the
corporation.
A) preferred stockholders
B) unsecured creditors
C) common stockholders
D) secured creditors
Answer: C

62
17- Because equity holders are the last to receive any distribution of
assets as a result of bankruptcy proceedings, common stockholders
expect
A) fixed dividend payments.
B) greater compensation in the form of dividends and/or rising stock
prices.
C) all profits to be paid out in dividends.
D) warrants to be attached to the stock issue as a sweetener.
Answer: B

18- A common stock currently has a beta of 1.7, the risk-free rate is 7
percent annually, and the market return is 12 percent annually. The stock
is expected to generate a constant dividend of $6.70 per share. A pending
lawsuit has just been dismissed and the beta of the stock drops to
1.4. The new equilibrium price of the stock
A) will be $55.83.
B) will be $43.23.
C) will be $47.86.
D) cannot be determined from the information given.
Answer: C

19- According to the efficient market theory,

A) prices of actively traded stocks can be under- or over-valued in an
efficient market, and bear searching out.
B) prices of actively traded stocks can only be under-valued in an
efficient market.
C) prices of actively traded stocks do not differ from their true values in
an efficient market.
D) prices of actively traded stocks can only be over-valued in an efficient
market.
Answer: C

20- ________ in the beta coefficient normally causes ________ in the

required return and therefore ________ in the price of the stock, all else
remaining the same.
A) An increase; an increase; an increase

63
B) An increase; a decrease; an increase
C) An increase; an increase; a decrease
D) A decrease; a decrease; a decrease
Answer: C

21- Nico Corporationʹs common stock currently sells for $180 per share.
Nico just paid a dividend of $10.18 and dividends are expected to grow at
a constant rate of 6 percent forever. If the required rate of return is 12
percent, what will Nico Corporationʹs stock sell for one year from now?
A) $190.80
B) $187.04
C) $195.40
D) $179.84
Answer: A

64
 Chapter 6
Stock Valuation

1- Holders of equity have claims on both income and assets

that are secondary to the claims of creditors.

Answer: TRUE

Comment because the claims of creditors are primary, the

firm should satisfy all creditors before distributing any
dividends on the stock holders. And this clearly reflected in the
income statement.
65
2- Unlike creditors, equity holders are owners of the firm.

Answer: TRUE

Comment because the equity holders are the stock holders,

these stocks that they own represent their ownership
proportion in the firm, through it they can exercise their voting
rights in the general assembly, unlike creditors who just lend
the firm a certain amount of money in return for a specific
amount of interest.

3- Interest paid to bondholders is tax deductible but interest

paid to stockholders is not.

Answer: FALSE

Comment Interest paid to stockholders is tax deductible but

interest paid to bondholders is not.

4- Preferred stock has characteristics of debt since it provides

a fixed periodic cash payment.

Answer: TRUE

66
Comment because their financial treatment is as same as
creditors (bondholder & Bank), they have privilege in dividends
distribution; they receive a constant fixed dividends
periodically. For that reason preferred stockholders don’t have
any voting rights.

5- A call feature is a feature that allows preferred

stockholders to change each share into a stated number of
shares of common stock.

Answer: FALSE

Comment this is the conversion feature, the preferred stock

holders will exercise this feature when the dividends received
on the stated number of common stocks exceeds the dividends
received on one preferred stock.

6- Common stockholders are often referred to as residual

claimants (owners).

Answer: TRUE

Comment because common stock holders are the real

owners of the firm, they receive what remains after satisfying
all creditors and preferred stock dividends.

67
Comment because common stock holders bear the actual
results of any action taken by the company management. They
are the real owners of the firm.

7- A common stockholder has no guarantee of receiving any

cash inflows, but receives what is left after all other claims on
the firm's income and assets have been satisfied.

Answer: TRUE

Comment because the common stock holders are the

residual owners of the firm, they are the real owners of the
firm. They receive what remained after satisfying creditors and
preferred stock dividends.

8- Investors purchase a stock when they believe that it is

undervalued and sell when they feel that it is overvalued.

Answer: TRUE

Comment because in this case investors will realize capital

gains.

68
9- To a buyer, an asset's value represents the minimum price
that he or she would pay to acquire it.

Answer: FALSE

Comment To a buyer, an asset's value represents the

maximum price that he or she would pay to acquire it. And this
maximum price is always represented by the present value of
all cash flows expected from this asset.

10- Efficient market hypothesis is the theory describing the

behavior of an assumed ʺperfectʺ market in which securities
are typically in equilibrium, security prices fully reflect all
public information available and react swiftly to new
information, and, because stocks are fairly priced, investors
need not waste time looking for mispriced securities.

Answer: TRUE

Comment in this case perfect competition conditions exist in

the market as there will be a large number of buyers and sellers
in the market, all information about goods (securities) and its
substitutes will exist, transaction cost will be free of tax so
stocks will be fairly priced and investors will not waste time in
looking for mispriced securities.

11- In an inefficient market, stock prices adjust quickly to new

public information.

69
Answer: FALSE

Comment this will be done only in the efficient market as in

an efficient market the stocks are fairly priced and the
conditions of perfect competition exist thus stock prices will
adjust quickly any to new public information.

12- There is a positive relationship between the growth rate

and the stock price in the constant growth model.

Answer: TRUE

Comment because the stock price mainly depends on the

dividends received, the higher the growth rate of the dividends
received the higher the stock price.

13- FCF valuation model determine the value of the entire

firm through discounting all expected dividends using a
discount rate equal to the weighted average cost of capital.

Answer: FALSE

Comment FCF valuation model determine the value of the

entire firm through discounting all expected free cash flows
(expected to be received by the firm till infinity) using a
discount rate equal to the weighted average cost of capital.

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14- It is easier to value stock than to find the value of the
bonds.

Answer: FALSE

Comment it is easier to value bonds than to value stocks,

because bonds have maturity will stocks have no maturity. In
addition there is no growth rate in bonds while in stocks the
growth rate might be zero, constant or variable.

15- In the Gordon model, there is a negative relationship

between the level of risk and the stock price.

Answer: TRUE

Comment in the constant growth model when the level of

risk increase the required rate of return will increase also
causing a reduction in the stock price, because when the level
of risk increase investors (most of them are risk avoiders) will
not buy the stock so the demand on the stock will decrease and
this will reduce the stock price.

16- When valuing common stock, capital gains used to

determine the stock's current value.

Answer: FALSE

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Comment when valuing common stock, expected dividends
is the only factor that affects the process of evaluation, capital
gains not used in determining the stock value.

17- When using the constant growth model, the constant

growth rate has to be greater than the required rate of return
in order for the model to be useful.

Answer: FALSE

Comment in the constant growth model the required rate of

return should always be greater than the constant growth rate
otherwise the model will be useless (negative stock price).

18- Under the efficient market hypothesis when the expected

return of a common stock is less than its required return,
investors will buy the stock and drive the price upward.

Answer: FALSE

Comment when the expected return is less than the required

return (bad news), stock holders will sell their stocks and initial
investors will never buy this stock as they will receive a rate
lower than the rate they require, in this case the supply of
stocks will increase and the demand for stocks will decrease
and this will drive the stock price downward.

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19- Variable growth model used in evaluating common stocks
can be also used in evaluating preferred stocks.

Answer: FALSE

Comment:  the Zero growth model is the model that can be

used in evaluating preferred stocks as preferred stock holders
receive a constant fixed dividends each period.

20- Stock market efficiency says that the price of a security

accurately reflect all available information about the firm.

Answer: TRUE

Comment because the efficient market will reflect right away

any new information about stocks traded in the market, this
information might be good news or bad news and it will be
directly related to the firm.

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