Chapter 8 Questions

# Chapter 8 Questions - Chapter 8 Test Questions Question 1...

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Chapter 8 Test Questions

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Question 1 Which of the following investments is clearly preferred to the others? Return Risk A 18% 20% B 20% 20% C 20% 18% a) Investment A b) Investment B c) Investment C d) Cannot be determined
Answer Question 1 In this case we notice that there is no information given regarding the value of diversifiable and non-diversifiable risk. Though Investment C looks the best it could be that all the risk is non-diversifiable risk whereas Investment B could be mostly diversifiable risk and thus a less risky investment for the same return. Answer : D

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Question 2 You are considering investing in U.S. Steel. Which of the following is an example of nondiversifiable risk? a) Risk resulting from foreign expropriation of U.S. Steel property b) Risk resulting from oil exploration by Marathan Oil (a U.S. Steel subsidy) c) Risk resulting from a strike against U.S. Steel d) None of the above
Answer Question 2 Examples of nondiversifiable risk include unexpected changes in interest rates, unexpected changes in cash flows due to tax changes, business cycles, and other overall market factors such as wars. All of the examples stated were firm-specific risk factors. Answer : D

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Question 3 Sterling Incorporated has a beta of 1.0. If the expected return on the market is 12%, what is the expected return on Sterling Incorporated’s Stock? a) 9% b) 10% c) 12% d) Insufficient information is provided
Answer Question 3 Since the beta of Sterling Incorporated is 1.0 we know that it will have the same return as the market. CAPM formula is Risk Free + Beta * (Market Return – Risk Free). If Beta is 1 then the formula is Risk Free + Market Return – Risk Free or just Market Return. Answer : C

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Question 4 Siebling Manufacturing Company’s common stock has a beta of .8. If the expected risk- free return is 7% and the market offers a premium of 8% over the risk-free rate, what is the expected return n Sierbling’s common stock? a) 7.8% b) 13.4% c) 14.4% d) 8.7%
Using the CAPM we get .07 + .8*.08 = 13.4%. Be careful to read the problem carefully. The 8% is the market risk premium not the return on the market. Answer : B

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## This note was uploaded on 12/19/2011 for the course BUS M 301 taught by Professor Jimbrau during the Fall '11 term at BYU.

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Chapter 8 Questions - Chapter 8 Test Questions Question 1...

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