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Finance 357: Business Finance (03085) After graduating from the McCombs School of Business, you are hired by Silver Sachs as its investment banker. You are given with the following tasks: 1. ( True or False ) The CEO of your client firm, Outel Inc., is confused with many of the financial concepts, and sometimes makes false statements. For each of the following statements, evaluate whether it is true or false. If false, explain why. a) (1 point) Shareholders’ liability is limited to the amount invested in shares. True. b) (1 point) Geometric average is always greater than arithmetic average. False . As long volatility exists in the return, arithmetic average is always greater than the geometric average. c) (1 point) A risk neutral investor would not mind a zero risk premium. True . They are indifferent about risk d) (1 point) Portfolio standard deviation is the weighted average of the standard deviations of the individual assets in the portfolio. False . As long as the correlations between the individual assets are not “1,” portfolio standard deviation is always lower than the weighted average. e) (1 point) Beta of a risk free asset is zero. True . By definition, return on a risk-free asset does not commove with market return. f) (1 point) If a coupon bond is traded below par, the yield-to-maturity (YTM) is lower than the coupon rate. False . If a bond is traded below par, it means the bond price is lower than the par value. Thus, YTM is higher than the coupon rate. g) (1 point) Cash cow refers to a firm that pays out all of its earnings as dividends. True . h) (1 point) The greater the risk, the higher the P/E ratio. False . Higher risk increases beta and thus the cost of equity. But, P/E ratio is inversely related to the cost of equity. So, P/E ratio drops with higher risk. i)

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