FINANCIAL MANAGEMENT 2017  QUIZ AND CASE STUDY GUIDES
Financial Management: Core Concepts, 3e (Brooks)
Chapter 8 Risk and Return
Financial Management: Core Concepts, 3e (Brooks)
Chapter 8 Risk and Return
8.1 Returns
1) Which of the statements below is TRUE?
 A) Investors want to maximize return and maximize risk.
 B) Investors want to maximize return and minimize risk.
 C) Investors want to minimize return and maximize risk.
 D) Investors want to minimize return and minimize risk.
Answer: B
Diff: 1
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
2) Richard bought a share of stock for $47.50 that paid a dividend of $.72 and sold one year later for $51.38. What was Richard's dollar profit or loss and holding period return?
 A) $0.72, 7.55%
 B) $3.88, 8.95%
 C) $4.60, 9.68%
 D) $3.88, 9.68%
Answer: C
Explanation: C) Profit = Ending Value + Distributions  Original Cost
Profit = $51.38 + $0.72  $47.50 = $4.60.
HPR = = = 9.68%.
Diff: 2
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
3) Ralph bought a share of stock for $31.50 that paid a dividend of $.85 and sold six months later for $27.65. What was his dollar profit or loss and holding period return?
 A) $3.00, 9.52%
 B) $3.85, 12.22%
 C) $.85, 2.70%
 D) $3.85, 9.52%
Answer: A
Explanation: A) Profit = Ending Value + Distributions  Original Cost
Profit = $27.65 + $0.85  $31.50 = $3.00.
HPR = = = 9.52%.
Diff: 2
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
4) Gary bought a share of stock for $15.75 that paid a dividend of $.45 and sold three months later for $18.65. What was his dollar profit or loss and holding period return?
 A) $2.90, 18.41%
 B) $3.35, 21.27%
 C) $2.90, 18.41%
 D) $.45, 2.86%
Answer: B
Explanation: B) Profit = Ending Value + Distributions  Original Cost
Profit = $18.65 + $0.45  $15.75 = $3.35.
HPR = = = 21.27%.
Diff: 2
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
5) Rose bought a share of stock for $64.50 that paid a dividend of $.50 and sold nine months later for $64.00. What was her dollar profit or loss and holding period return?
 A) $0.50, 0.78%
 B) $0.50, 0.78%
 C) $0.00, 0.00%
 D) There is no correct solution to this question.
Answer: C
Explanation: C) Profit = Ending Value + Distributions  Original Cost
Profit = $64.00 + $0.50  $64.50 = $0.00.
HPR = = = 0.00%.
Diff: 2
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
6) Tom purchased Hampton Industries Inc. stock for $14.65 and sold it 6 months later for $17.38 after receiving a $0.25 dividend. What Tom's holding period return (HPR), Annual Percentage Rate (APR), and Effective Annual Rate (EAR)?
 A) 20.34%, 40.68%, 9.70%
 B) 18.63%, 37.27%, 40.74%
 C) 17.15%, 34.29%, 37.23%
 D) 20.34%, 40.68%, 44.82%
Answer: D
Explanation: D) HPR = = = 20.34%,
APR = = = 40.68%, EAR = (1 + HPR)(1/n)  1 = (1.2034)(2)  1 = 44.82%.
In this case, n =0.5 years.
Diff: 3
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
7) Robert invested in stock and received a positive return over a 9month period. Which of the following types of returns will be greater?
 A) Holding period return (HPR)
 B) Effective annual return
 C) Annual percentage rate
 D) There is not enough information to make a definitive choice.
Answer: B
Explanation: B) The holding period return is for only nine months. The other choices are forms of annual returns and will be greater than the HPR if the HPR is positive.
Diff: 1
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
8) Your investment advisor informs you that you do not need to pay a fee for his services. Instead, he invests your money for one month and keeps all of the proceeds before investing it for you. If your advisor makes and keeps a 2% return on your investment, what is his EAR if the earnings rate could be extrapolated for one year?
 A) 2.00%
 B) 24.00%
 C) 26.82%
 D) 126.82%
Answer: C
Explanation: C) EAR = (1 + hpr) (1/n)  1 = (1.02)(12)  1 = 26.82%.
Diff: 2
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
9) You purchased 100 shares of stock for $5 per share. After holding the stock for 8 years and not receiving any dividends, you sell the stock for $42 per share. What are the holding period and annual return on this investment?
 A) 920%, 41.63%
 B) 740%, 30.48%
 C) 625%, 27.66%
 D) 185%, 14.42%
Answer: B
Explanation: B) HPR = = ($42  $5)/$5 = 740%
EAR = (1 + hpr) (1/n)  1 = (1+7.4)(1/8)  1 = 30.48%.
Diff: 2
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
10) One definition of return is:
Answer: TRUE
Diff: 1
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
11) The holding period return (HPR) is the return measured from the initial purchase to the final sale of the investment without regard to the length of time the investment is held.
Answer: TRUE
Diff: 2
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
12) Simple interest is akin to the effective annual rate (EAR) and compound interest is akin to the annual percentage rate (APR).
Answer: FALSE
Explanation: Simple interest is akin to the annual percentage rate (APR), and compound interest is akin to the effective annual rate (EAR).
Diff: 1
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
13) Finance functions in a twoparameter world of risk and return. Define risk and return in a financial sense and discuss how these two concepts are "joined at the hip."
Answer: Investors desire to maximize return and minimize risk. Or put another way, they want to get the most out of their investments with the least amount of uncertainty. However, there is a direct tradeoff between risk and expected return. In order for investors to increase their expected return, they must be willing to bear greater risk or uncertainty. You cannot have one without the other; thus risk and return are "joined at the hip," so to speak.
Diff: 2
Topic: 8.1 Returns
AACSB: 3 Analytical Thinking
LO: 8.1 Calculate profits and returns on an investment and convert holding period returns to annual returns.
8.2 Risk (Certainty and Uncertainty)
1) ________ is the absence of knowledge of the outcome of an event before it happens.
 A) Return
 B) Diversification
 C) Uncertainty
 D) Certainty
Answer: C
Diff: 1
Topic: 8.2 Risk (Certainty and Uncertainty)
AACSB: 1 Written and Oral Communication
LO: 8.2 Define risk and explain how uncertainty relates to risk.
2) ________ may be defined as a measure of uncertainty in a set of potential outcomes for an event in which there is a chance for some loss.
 A) Diversification
 B) Risk
 C) Uncertainty
 D) Collaboration
Answer: B
Diff: 1
Topic: 8.2 Risk (Certainty and Uncertainty)
AACSB: 1 Written and Oral Communication
LO: 8.2 Define risk and explain how uncertainty relates to risk.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
3) The practice of not putting all of your eggs in one basket is an illustration of ________.
 A) variance
 B) diversification
 C) portion control
 D) expected return
Answer: B
Diff: 1
Topic: 8.2 Risk (Certainty and Uncertainty)
AACSB: 1 Written and Oral Communication
LO: 8.2 Define risk and explain how uncertainty relates to risk.
4) Which of the following investments is considered to be default riskfree?
 A) Currency options
 B) AAA rated corporate bonds
 C) Common stock
 D) Treasury bills
Answer: D
Diff: 1
Topic: 8.2 Risk (Certainty and Uncertainty)
AACSB: 1 Written and Oral Communication
LO: 8.2 Define risk and explain how uncertainty relates to risk.
5) Even if there is certainty of future payoffs, there can still be risk.
Answer: FALSE
Diff: 1
Topic: 8.2 Risk (Certainty and Uncertainty)
AACSB: 3 Analytical Thinking
LO: 8.2 Define risk and explain how uncertainty relates to risk.
6) Define risk. Give an example of a riskfree investment and explain why you claim it has no risk. Give an example of a risky investment and explain why you claim the investment to be risky.
Answer: Risk is a measure of the uncertainty in a set of potential outcomes for an event in which there is a chance of some loss. The typical riskfree investment example is Treasury bills because the investor knows with certainty the amount and timing of the investment payoff. In all states of the world, an investor in Treasury bills will receive the face value of the investment. Risky investments have uncertain outcomes. Stocks, bonds, commodities, real estate, and many other types of investments provide uncertain returns. Some investments have returns that vary only by small amounts across states of the world, while others vary much more from very negative to very positive.
Diff: 3
Topic: 8.2 Risk (Certainty and Uncertainty)
AACSB: 3 Analytical Thinking
LO: 8.2 Define risk and explain how uncertainty relates to risk.
8.3 Historical Returns
1) The textbook provides a history of returns from 1950 through 1999 for four classifications of securities in the United States. Rank the average returns from the highest to lowest over this time period.
 A) Largecompany stocks, smallcompany stocks, 3month U.S. Treasury bills, longterm government bonds
 B) Longterm government bonds, 3month U.S. Treasury bills, smallcompany stocks, largecompany stocks
 C) Smallcompany stocks, largecompany stocks, longterm government bonds, 3month U.S. Treasury bills
 D) Largecompany stocks, longterm government bonds, smallcompany stocks, 3month U.S. Treasury bills
Answer: C
Diff: 2
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
2) The textbook provides a history of returns from 1950 through 1999 for four classifications of securities in the United States. Rank the average standard deviation ( measure of risk) from the highest to lowest over this time period.
 A) Largecompany stocks, smallcompany stocks, 3month U.S. Treasury bills, longterm government bonds
 B) Longterm government bonds, 3month U.S. Treasury bills, smallcompany stocks, largecompany stocks
 C) Smallcompany stocks, largecompany stocks, longterm government bonds, 3month U.S. Treasury bills
 D) Largecompany stocks, longterm government bonds, smallcompany stocks, 3month U.S. Treasury bills
Answer: C
Diff: 2
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
3) Which of the following classifications of securities had the largest range of annual returns over the period 19501999?
 A) Largecompany stocks
 B) Longterm government bonds
 C) Smallcompany stocks
 D) 3month U.S. Treasury bills
Answer: C
Diff: 1
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
4) Which of the following classifications of securities had the smallest range of annual returns over the period 19501999?
 A) Largecompany stocks
 B) Longterm government bonds
 C) Smallcompany stocks
 D) 3month U.S. Treasury bills
Answer: D
Diff: 1
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
5) Which of the following classifications of securities had the largest oneyear return over the period 19501999?
 A) Smallcompany stocks
 B) Longterm government bonds
 C) 3month U.S. Treasury bills
 D) Largecompany stocks
Answer: A
Diff: 1
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
6) Which of the following classifications of securities had the smallest oneyear return over the period 19501999?
 A) Longterm government bonds
 B) 3month U.S. Treasury bills
 C) Smallcompany stocks
 D) Largecompany stocks
Answer: C
Diff: 1
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
7) Which of the following classifications of securities had NO negative oneyear returns over the period 19501999?
 A) Longterm government bonds
 B) Largecompany stocks
 C) 3month U.S. Treasury bills
 D) Each of the classification of securities listed experienced at least one negative oneyear return over the listed time period.
Answer: C
Diff: 2
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
8) Which of the following ranges of annual returns best describes the variability for smallcompany stocks in the United States for the period 19501999?
 A) 0% to 15%
 B) 10% to 40%
 C) 30% to 55%
 D) 40% to 100%
Answer: D
Diff: 2
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
9) If you were required to estimate the average return for one category of securities for the coming year, history tells us that you should have the greatest degree of confidence estimating which of the following?
 A) Longterm government bonds
 B) 3month U.S. Treasury bills
 C) Smallcompany stocks
 D) Largecompany stocks
Answer: B
Diff: 2
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
10) Historically, the ________ risk an investor is willing to accept, the ________ the potential return for the investment.
 A) more; lesser
 B) less; greater
 C) more; greater
 D) Historically, the risk/return tradeoff has not played out in any particular manner.
Answer: C
Diff: 2
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
11) Over the 50year period from 1950 to 1999, 3month Treasury bills earned a higher average annual rate of return than longterm government bonds.
Answer: FALSE
Explanation: Longterm government bonds earned an average annual return of 5.94%, and Treasury bills earned an average return of 5.23%.
Diff: 1
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
12) Over the 50year period from 1950 to 1999, 3month Treasury bills earned a positive average annual rate of return in each year.
Answer: TRUE
Diff: 1
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
13) The chart below gives information for four classes of U.S. securities over the 50year time period from 19501999. Order the securities from highest average annual return to lowest for this time period. Now rank the securities from highest to lowest based on risk. Is the information consistent with what financial theory tells us? Why or why not?
Answer: The text reports the following in Section 8.3:
Class of Security 
Average Annual Return 1950  1999 
Standard Deviation 
Small Stocks 
17.10% 
29.04% 
Large Stocks 
14.89% 
16.70% 
Longterm Government Bonds 
5.94% 
9.49% 
3Month U.S. Treasury Bills 
5.23% 
2.98% 
The returns over this time period are consistent with what we expect from financial theory in that increased expected return is accompanied by increased risk. Here, we can define risk as the standard deviation or uncertainty of returns. As the table shows, the return and standard deviation of return are directly related. Students should not be required to know the exact values to complete this table; however, they should be aware of the relative levels of risk and return among the various classifications of securities.
Diff: 3
Topic: 8.3 Historical Returns
AACSB: 3 Analytical Thinking
LO: 8.3 Appreciate the historical returns of various investment choices.
8.4 Variance and Standard Deviation as a Measure of Risk
1) Which of the following statements is true about variance?
 A) Variance describes how spread out a set of numbers or a value is around its mean or average.
 B) Variance is essentially the variability from the average.
 C) The larger the variance, the greater the dispersion.
 D) All of the above statements are true.
Answer: D
Diff: 2
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
2) Find the variance for a security that has three oneyear returns of 5%, 10%, and 15%.
 A) 10.00%
 B) 16.67%
 C) 25.00%
 D) 30.00%
Answer: C
Explanation: C) Average return = Σrt/n = (5% + 10% + 15%)/3 = 10%
Variance(r) = Σ (ri  average)2 / (n  1)
= Σ[(5%  10%)2 + (10%  10%)2 + (15%  10%)2]/(3  1) = 25%
Diff: 3
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
3) Find the variance for a security that has three oneyear returns of 5%, 15%, and 20%.
 A) 175.00%
 B) 75.00%
 C) 58.33%
 D) 25.00%
Answer: A
Explanation: A) Average return = Σrt/n = (5% + 15% + 20%)/3 = 10%
Variance(r) = Σ (ri  average)2 / (n  1)
= Σ[(5%  10%)2 + (15%  10%)2 + (20%  10%)2]/(3  1) = 175%.
Diff: 3
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
4) Stocks A, B, C, and D have standard deviations, respectively, of 20%, 5%, 10%, and 15%. Which one is the riskiest?
 A) Stock A
 B) Stock B
 C) Stock C
 D) Stock D
Answer: A
Explanation: A) The higher the standard deviation, the higher the volatility or risk.
Diff: 3
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
5) A more risky stock has a higher ________.
 A) expected return
 B) standard deviation
 C) variance
 D) B and C
Answer: D
Explanation: D) Standard deviation and variance essentially tell you the same thing—a stock's volatility or risk.
Diff: 3
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
6) Stocks A, B, C, and D have returns of 10%, 20%, 30%, and 40%, respectively. What is their variance?
 A) 66.67%
 B) 166.67%
 C) 4.08%
 D) 2.15%
Answer: B
Explanation: B) Mean return = (10% + 20% + 30% + 40%)/4 = 25%, so
variance = [(10%  25%)2 + (20%  25%)2 + (30%  25%)2 + (40%  25%)2]/(4  1)
= 500% /3 = 166.67%.
Diff: 3
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
7) Stocks A, B, C, and D have returns of 5%, 15%, 30%, and 110%, respectively. What is their standard deviation?
 A) 64.25%
 B) 56.75%
 C) 47.78%
 D) 32.05%
Answer: C
Explanation: C) Mean return = (5% + 15% + 30% + 110%)/4 = 40%, so
variance = [(5%  40%)2 + (15%  40%)2 + (30%  40%)2 + (110%  40%)2]/(4 1 )
= 2,283.33%. So, standard deviation = the square root of the variance = 47.78%.
Diff: 3
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
8) The larger the variance, the smaller the dispersion.
Answer: FALSE
Explanation: The larger the variance, the greater the dispersion.
Diff: 1
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
9) Over the 50year period from 1950 to 1999, the portfolio of large U.S. stocks has had a greater variance than the portfolio of small U.S. stocks.
Answer: FALSE
Explanation: The variance for large stocks was 278.89%, and for small stocks the variance was 843.32%.
Diff: 1
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
10) Evidence from the 50year period from 1950 to 1999 indicates that returns and risk (as measured by the standard deviation of returns) are positively related.
Answer: TRUE
Diff: 1
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
11) Most stock analysts would agree that more variance is an indicator of less risk.
Answer: FALSE
Explanation: Most stock analysts would agree that more variance is an indicator of MORE risk.
Diff: 1
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
12) If stock A has a greater standard deviation than stock B then it must also have a greater return.
Answer: FALSE
Explanation: If stock A has a greater standard deviation than stock B then it WILL LIKELY have a greater EXPECTED return.
Diff: 1
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
13) Explain how the statistical concepts of mean and standard deviation apply to the financial ideas of risk and return.
Answer: One common definition of risk is that it is the probability of getting a return different from what you expect. Calculating an average rate of return gives you a reasonable expectation. Then calculating the standard deviation lets you apply the normal curve probabilities around that expectation. So, for example, if you calculate a 10% expected rate of return and a 5% standard deviation, then you can estimate a 34% probability of making a return of between 10% and 15%, or a 16% probability of making more than 15%, or an 84% chance of making less than 15%.
Diff: 3
Topic: 8.4 Variance and Standard Deviation as a Measure of Risk
AACSB: 3 Analytical Thinking
LO: 8.4 Calculate standard deviations and variances with historical data.
8.5 Returns in an Uncertain World (Expectations and Probabilities)
1) Which of the following statements about probabilities is INCORRECT?
 A) The sum of all probabilities of a particular event must sum to 100%.
 B) Each possible outcome must have a nonnegative probability.
 C) Probability is a statistical tool for estimating future outcomes.
 D) Probability is associated with an expost view.
Answer: D
Explanation: D) Probability is associated with an exante view.
Diff: 2
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
2) You are considering buying a share of stock in a firm that has the following two possible payoffs with the corresponding probability of occurring. The stock has a purchase price of $15.00. You forecast that there is a 30% chance that the stock will sell for $30.00 at the end of one year. The alternative expectation is that there is a 70% chance that the stock will sell for $10.00 at the end of one year. What is the expected percentage return on this stock, and what is the return variance?
 A) 6.67%, 9.17%
 B) 1.00%, 93.50%
 C) 6.67%, 37.33%
 D) 84.00%, $9.67
Answer: C
Explanation: C) Expected payoff = Σ Expected payoffi × probabilityi = .30 ∗ $30.00 + .70 ∗ $10 = $16.00.
E(r) = = = 6.67%
Variance = (0.30)(1.00  0.0667)2 + (0.70)(0.333  0.0677)2 = 0.377, or 37.33%.
Diff: 3
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
3) You are considering buying a share of stock in a firm that has the following two possible payoffs with the corresponding probability of occurring. The stock has a purchase price of $50.00. You forecast that there is a 40% chance that the stock will sell for $70.00 at the end of one year. The alternative expectation is that there is a 60% chance that the stock will sell for $30.00 at the end of one year. What is the expected percentage return on this stock, and what is the return variance?
 A) 8.00%, 15.36%
 B) 4.00%, 30.72%
 C) 8.00%, 15.36%
 D) 4.00%, 30.72%
Answer: A
Explanation: A) Expected payoff = Σ Expected payoffi × probabilityi = .40 ∗ $70.00 + .60 ∗ $30 = $46.00.
E(r) = = = 8.00%
Variance = (0.40)(0.40  (.08))2 + (0.60)(0.40  (0.08))2 = 0.1536, or 15.36%.
Diff: 3
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
4) Your investment banking firm has estimated what your new issue of bonds is likely to sell for under several different economic conditions. What is the expected (average) selling price of each bond?

Recession 
Steady 
Boom 
Probability 
.25 
.65 
.10 
Bond price 
$970 
$1,000 
$1,150 
 A) $1,000.00
 B) $1,007.50
 C) $1,040.00
 D) $1,100.33
Answer: B
Explanation: B) Expected payoff = Σ payoffi × probabilityi = .25 ∗ $970 + .65 ∗ $1,000 + .10 ∗ $1,150 = $1,007.50.
Diff: 2
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
5) Given the expected returns and probabilities of various states of the world in this table, what is the expected return for Carbide Company?
Carbide Company
State of the Economy 
Probability of State 
Return on State 
Boom 
.30 
18% 
Steady 
.55 
10% 
Recession 
.15 
5% 
 A) 10.15%
 B) 5.40%
 C) 5.50%
 D) 0.75%
Answer: A
Explanation: A) Expected payoff = Σ payoffi × probabilityi = .30 ∗ 18% + .55 ∗ 10% + .15 ∗ 5% = 10.15%
Diff: 2
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
6) Ronnie estimates that there are three possible return outcomes for a stock he is considering for purchase. He thinks that there is a 45% chance the economy will boom and his stock will return 25%, a 50% chance the economy will continue at its current pace and the stock will return 8%, and finally, that there is a 5% chance that the economy will falter and the expected return on his stock will be 10%. Given these probabilities and conditional expected returns, what is Ronnie's expected return on the stock he is considering for purchase?
 A) 8.00%
 B) 11.25%
 C) 14.75%
 D) 15.25%
Answer: C
Explanation: C) Expected payoff = Σ payoffi × probabilityi = .45 ∗ 25% + .50 ∗ .08% + .05% ∗ 10% = 14.75%.
Diff: 2
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
7) George is considering an investment in Parson Inc. and has gathered the following information. What is the expected return for a share of the firm's stock?
State of the Economy 
Probability of the State 
Conditional Expected Return Parson Inc. 
Recession 
.25 
20% 
Steady 
.60 
10% 
Boom 
.15 
35% 
 A) 5.00%
 B) 6.25%
 C) 8.33%
 D) 10.00%
Answer: B
Explanation: B) Expected payoff = Σ payoffi × probabilityi = .25 ∗ 20% + .60 ∗ 10% + .15 ∗ 35% = 6.25%.
Diff: 2
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
8) Andre is considering an investment in Bristol Inc. and has gathered the following information. What is the expected return for a share of the firm's stock?
State of the Economy 
Probability of the State 
Conditional Expected Return Bristol Inc. 
Recession 
.20 
10% 
Steady 
.50 
10% 
Boom 
.30 
45% 
 A) 45.00%
 B) 65.00%
 C) 16.50%
 D) 15.00%
Answer: C
Explanation: C) Expected payoff = Σ payoffi × probabilityi = .20 ∗ 10% + .50 ∗ 10% + .30 ∗ 45% = 16.50%.
Diff: 2
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
9) Andre is considering an investment in Bristol Inc. and has gathered the following information. What is the expected standard deviation for a share of the firm's stock?
State of the Economy 
Probability of the State 
Conditional Expected Return Bristol Inc. 
Recession 
.20 
10% 
Steady 
.50 
10% 
Boom 
.30 
45% 
 A) 17.48%
 B) 122.63%
 C) 20.13%
 D) 5.14%
Answer: C
Explanation: C) Standard deviation = Σ[(rs  E(r))2 ∗ probs]1/2
= [(10%  16.50%)2 ∗ .20 + (10%  16.50%)2 ∗ .50 + (45%  16.50%)2 ∗ .30]1/2
= 20.13%.
Diff: 3
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
10) George is considering an investment in Parson Inc. and has gathered the information in the following table. What is the expected standard deviation for a share of the firm's stock?
State of the Economy 
Probability of the State 
Conditional Expected Return Parson Inc. 
Recession 
.25 
20% 
Steady 
.60 
10% 
Boom 
.15 
35 
 A) 17.46%
 B) 22.48
 C) 27.54%
 D) 31.62%
Answer: A
Explanation: A) Standard deviation = Σ[(rs  E(r))2 ∗ probs]1/2
= [(20%  6.25%)2 ∗ .25 + (10%  6.25%)2 ∗ .60 + (35%  6.25%)2 ∗ .15]1/2 = 17.46%.
Diff: 3
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
11) When looking at the history of returns, we are taking an "exante" review and when we are looking at the future of returns we are taking an "expost" view.
Answer: FALSE
Explanation: When looking at the history of returns we are taking an "expost" review and when we are looking at the future of returns we are taking an "exante" view.
Diff: 1
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
12) Use the information in the table to calculate the expected return and standard deviation of an equallyweighted portfolio.
Answer: Expected Return = 7.00%; standard deviation = 0.33%
Explanation: To find the expected return for an equallyweighted portfolio, first find the expected return in each state via the formula E(rs) = (Σri)/n. For the boom state the expected return is 6.67%, Normal = 6.67%, and Bust period expected return = 7.33%. The expected return for the portfolio = E(rp) = (Σrs) ∗ probability of the state of the world = (6.67% ∗ .20) + (6.67 ∗ .30) + (7.33% ∗ .50) = 7.00%.
The standard deviation = [Σ(rs  E(r))2 ∗ probabilitys](1/2) = [(6.67%  7.00%)2 ∗ .20 +(6.67%  7.00%)2 ∗.30 + (7.33%  7.00%)2 ∗ .50](1/2) = 0.33%.
Diff: 3
Topic: 8.5 Returns in an Uncertain World (Expectations and Probabilities)
AACSB: 3 Analytical Thinking
LO: 8.5 Calculate expected returns and variances with conditional returns and probabilities.
8.6 The RiskandReturn Tradeoff
1) Use the following table:
States of the Economy 
Probability of the State 
3Month TBill 
LargeCompany Stock 
SmallCompany Stock 
Boom 
0.3 
4% 
10% 
30% 
Steady 
0.5 
4% 
5% 
20% 
Recession 
0.2 
4% 
0% 
10% 
What is the difference between the variances for large and smallcompany stocks?
 A) 40.25%
 B) 36.75%
 C) 27.30%
 D) 14.90%
Answer: B
Explanation: B)

3Month TBill 
LargeCompany Stock 
SmallCompany Stock 
Er= 
4% 
5.5% 
21% 
VAR= 
0% 
12.25% 
49% 
STDEV= 
0% 
3.5% 
7% 
So 49%  12.25% = 36.75%.
Diff: 2
Topic: 8.6 The RiskandReturn Tradeoff
AACSB: 3 Analytical Thinking
LO: 8.6 Interpret the tradeoff between risk and return.
2) Use the following table:
States of the Economy 
Probability of the State 
3Month TBill 
LargeCompany Stock 
SmallCompany Stock 
Boom 
0.3 
4 
10 
30 
Steady 
0.5 
4 
5 
20 
Recession 
0.2 
4 
0 
10 
What is the difference between the standard deviation of a smallcompany stock and a 3month Tbill?
 A) 7.0%
 B) 5.5%
 C) 4.0%
 D) 3.5%
Answer: A
Explanation: A) 7%  0% = 7%.
Diff: 2
Topic: 8.6 The RiskandReturn Tradeoff
AACSB: 3 Analytical Thinking
LO: 8.6 Interpret the tradeoff between risk and return.
3) Stock A B C D
Expected Return 5% 5% 7% 6%
Standard Deviation 10% 12% 12% 11%
Which of the following statements is true?
 A) A is a better investment than B.
 B) B is a better investment than C.
 C) C is a better investment than D.
 D) D is a better investment than C.
Answer: A
Explanation: A) The only sure thing we know is that investment A is better than investment B because for the same return we get less risk. Investment B is not better than investment C because for the same risk, we get less return. We cannot say if investment C or investment D is better because that involves a personal judgment on the riskreturn tradeoff.
Diff: 2
Topic: 8.6 The RiskandReturn Tradeoff
AACSB: 3 Analytical Thinking
LO: 8.6 Interpret the tradeoff between risk and return.
4) Which of the statements below is NOT correct?
 A) If two investments have the same expected return, the investment with the lower risk is preferred.
 B) If two investments have the same expected return, the investment with the greater risk is preferred.
 C) If two investments have the same expected risk, the investment with the higher expected return is preferred.
 D) If one investment has a higher expected return and a greater level of risk than another, it is not clear which investment is the preferred choice.
Answer: B
Explanation: B) If two investments have the same expected return, the investment with the LOWER risk is preferred.
Diff: 1
Topic: 8.6 The RiskandReturn Tradeoff
AACSB: 3 Analytical Thinking
LO: 8.6 Interpret the tradeoff between risk and return.
5) If two investments have the same expected return, a rational investor will choose the investment with the greater risk in an effort to get a much larger return.
Answer: FALSE
Explanation: If two investments have the same expected return, a rational investor will choose the investment with the LESSER risk in an effort to minimize uncertainty.
Diff: 2
Topic: 8.6 The RiskandReturn Tradeoff
AACSB: 3 Analytical Thinking
LO: 8.6 Interpret the tradeoff between risk and return.
6) If two investments have the same level of risk, a rational investor will choose the investment with the higher expected rate of return.
Answer: TRUE
Diff: 1
Topic: 8.6 The RiskandReturn Tradeoff
AACSB: 3 Analytical Thinking
LO: 8.6 Interpret the tradeoff between risk and return.
7) What are the two investment rules identified in the text? Evaluate the validity of the following statement and justify your reasoning. "Investors do not like risk and will always choose the investment with the least risk."
Answer: The two rules identified by the author are: 1. If two investments have the same expected return and different levels of risk, the investment with the lower risk is preferred. 2. If two investments have equal risk, the investment with the higher expected return is preferred.
As for the statement, it is true that investors "don't like risk" to the extent that they do not willingly accept greater risk without increased expected return. That does not imply that investors will always choose the investment with the least amount of risk. An investor may choose an investment with greater risk if the rewardtorisk tradeoff is favorable.
Diff: 2
Topic: 8.6 The RiskandReturn Tradeoff
AACSB: 3 Analytical Thinking
LO: 8.6 Interpret the tradeoff between risk and return.
8.7 Diversification: Minimizing Risk or Uncertainty
1) Diversification is
 A) not putting all of your eggs in one basket.
 B) spreading wealth over a variety of investment opportunities.
 C) a common investment strategy.
 D) All of the above
Answer: D
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
2) An investor's total investment set may be referred to as ________.
 A) the stock market
 B) diversification
 C) a financial portfolio
 D) None of the above
Answer: C
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
3) When considering expected returns, what is true about the states of the world?
 A) They must have probabilities that sum to 100%.
 B) They represent all possible outcomes.
 C) They are sometimes simplified into outcomes such as boom, bust, and normal.
 D) Statements A through C are all true.
Answer: D
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
4) Richard has two investment opportunities. He can invest in The Sunglasses Company or The Umbrella Company. What is the expected return and standard deviation of each company?
State of the Economy 
Probability of the State 
Expected Return Sunglasses Company 
Expected Return Umbrella Company 
Sunny 
.50 
25% 
0% 
Rainy 
.50 
0% 
25% 
 A) The expected return for each company is 12.50% and the standard deviation for each company is 0.00%.
 B) The expected return for each company is 12.50% and the standard deviation for each company is 12.50%.
 C) The expected return for each company is 12.50% and the standard deviation for each company is 156.25%.
 D) The expected return for each company is 12.50% and the standard deviation for each company is 25.00%.
Answer: B
Explanation: B) Expected payoff = Σ payoffi × probabilityi = .50 ∗ 25% + .50 ∗ 0% = 12.50%.
Standard deviation = Σ[(rs  E(r))2 ∗ probs]1/2
= [(25%  12.5%)2 ∗ .50 + (0%  12.5%)2 ∗ .50]1/2 = 12.50%.
Diff: 3
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
5) Richard has two investment opportunities. He can invest in The Sunglasses Company or The Umbrella Company. If he diversifies his investment by putting 50% of his money into each company, what is the expected return and standard deviation of his portfolio?
State of the Economy 
Probability of the State 
Expected Return Sunglasses Company 
Expected Return Umbrella Company 
Sunny 
.50 
25% 
0% 
Rainy 
.50 
0% 
25% 
 A) The expected return for the portfolio is 12.50% and the standard deviation 0.00%.
 B) The expected return for the portfolio is 25.00% and the standard deviation 0.00%.
 C) The expected return for the portfolio is 12.50% and the standard deviation 12.50%.
 D) The expected return for the portfolio is 25.00% and the standard deviation 25.00%.
Answer: A
Explanation: A) The expected return is 12.50% in each state of the world, so the standard deviation is 0.0.
Diff: 3
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
6) Correlation, a standardized measure of how stocks perform relative to one another in different states of the economy, has a range from ________.
 A) 0.0 to +10.0
 B) 0.0 to +1.0
 C) 1.0 to +1.0
 D) There is no range; correlation is a calculated number that can take on any value.
Answer: C
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
7) The correlation coefficient, a measurement of the comovement between two variables, has what range?
 A) From 0.0 to +10.0
 B) From 0.0 to +1.0
 C) From 1.0 to +10.0
 D) From +1.0 to 1.0
Answer: D
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
8) For purposes of maximum portfolio diversification, which of the following would provide the greatest diversification?
 A) Security A with a correlation coefficient of 0.0
 B) Security B with a correlation coefficient of 0.0
 C) Security C with a correlation coefficient of 0.50
 D) Security D with a correlation coefficient of 0.50
Answer: C
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
9) The primary benefit of diversification is:
 A) an increase in expected return.
 B) an equal reduction in risk and return.
 C) a reduction in risk.
 D) Diversification has no real benefit; it is a shell game promoted by investment advisors who are the only real winners.
Answer: C
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
10) You wish to diversify your singlesecurity portfolio in a way that will maximize your reduction in risk. Which of the following securities should you add to your portfolio?
 A) Treasury bills that have a correlation coefficient of 0.0 with your current security
 B) Alpha Company stock that has a correlation coefficient of 0.25 with your current security
 C) Beta Company stock that has a correlation coefficient of 0.50 with your current security
 D) Delta Company bonds that have a correlation coefficient of 0.36 with your current security
Answer: B
Explanation: B) Negative correlation means that two different asset returns move in different directions over time. Thus one can offset the bad performance of the other.
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
11) Which of the following securities could NOT have any benefits for diversification with your investment portfolio?
 A) Treasury bills with a correlation coefficient of 0.0 with your portfolio
 B) Alpha Company stock that has a correlation coefficient of 0.25 with your portfolio
 C) Beta Company stock that has a correlation coefficient of 0.50 with your portfolio
 D) All of these choices would reduce risk for your portfolio and therefore show at least some benefit to diversification.
Answer: D
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
12) Which of the following statements is FALSE?
 A) The maximum benefits to diversification between securities occur when they are perfectly positively correlated.
 B) The maximum benefits to diversification between securities occur when they are perfectly negatively correlated.
 C) There is some benefit to diversification when the correlation between securities is 0.0.
 D) There is some benefit to diversification when the correlation between securities is greater than 0.0 but less than 1.0.
Answer: A
Explanation: A) The maximum benefits to diversification between securities occur when they are perfectly negatively correlated.
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
13) For most stocks, the correlation coefficient with other stocks is ________.
 A) positive
 B) negative
 C) zero
 D) The distribution of correlation coefficients between stocks is uniform from 1.0 to +1.0.
Answer: A
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
14) The type of risk that can be diversified away is called ________.
 A) unsystematic risk
 B) systematic risk
 C) nondiversifiable risk
 D) systemwide risk
Answer: A
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
15) Unsystematic risk
 A) is also known as nondiversifiable risk.
 B) can be diversified away.
 C) is systemwide risk.
 D) is equal to 2 times the systematic risk.
Answer: B
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
16) Assuming that stocks represent most industries, the number of stocks necessary to eliminate nearly all unsystematic risk varies from ________.
 A) 5 to 10
 B) 10 to 20
 C) 20 to 30
 D) 30 to 50
Answer: C
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
17) ________ is risk that cannot be diversified away.
 A) Unsystematic risk
 B) Systematic risk
 C) Firmspecific risk
 D) Diversifiable risk
Answer: B
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
18) The terms ________ and ________ mean the same thing.
 A) nondiversifiable risk; unsystematic risk
 B) diversifiable risk; systematic risk
 C) diversifiable risk; unsystematic risk
 D) total risk; unique risk
Answer: C
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
19) The truly wonderful thing about diversification is that 100% of risk can be diversified away, given a large enough portfolio.
Answer: FALSE
Explanation: Only unsystematic risk can be diversified away, not total risk.
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
20) While the covariance between stocks can take on a negative value, a correlation coefficient must be positive, or at a minimum, zero.
Answer: FALSE
Explanation: Correlation coefficients can range from a value of +1.0 to 1.0.
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
21) The more positive the degree of correlation between two assets, the greater the risk reduction when the assets are combined.
Answer: FALSE
Explanation: The LOWER the degree of correlation between two assets, the greater the risk reduction when the assets are combined.
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
22) Optimal risk reduction takes place when combining assets whose correlation coefficient is 0.0.
Answer: FALSE
Explanation: Optimal risk reduction takes place when combining assets whose correlation coefficient is 1.0.
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
23) When considering expected returns, the states of the world must sum to 1 (or 100%).
Answer: TRUE
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
24) Define diversification. What are the benefits to diversification? Will diversification always lead to greater expected portfolio returns?
Answer: Diversification is the practice of spreading your investment among different assets in an attempt to reduce the variability or uncertainty of returns. The benefit lies in the reduction of risk, not in the increase of expected returns. In fact, the expected return of a diversified portfolio consisting of assets with different expected rates of return will always have an expected return that is lower than the asset with the greatest expected return. So, no, diversification will NOT always lead to greater expected portfolio returns.
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
25) What is the possible range for a correlation coefficient? For purposes of diversification, what type of correlation coefficient among asset returns is preferred by investors? Explain why.
Answer: The range for a correlation coefficient is from a perfectly negative correlation of 1.0 to a perfectly positive correlation of +1.0. For diversification purposes, the lower the correlation coefficient, the greater the risk reduction and therefore, the greater the preference by investors for adding securities that have low to negative correlation coefficients with their existing portfolios. Keep in mind that most publicly traded stocks have positive correlation coefficients with one another.
Diff: 3
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
26) Define the terms systematic risk and unsystematic risk. Be sure to explain the difference between the two. Which type of risk can be diversified away? How do we measure the remaining type of risk? Evaluate the statement: "If we could just make our investment portfolio large enough, we could completely eliminate risk and earn a market portfolio rate of return with the risk of a riskfree investment."
Answer: Systematic risk is risk that cannot be diversified away, is measured with beta, and is the risk that impacts all stocks in an economy. On the other hand, unsystematic or diversifiable risk CAN be diversified away. This is risk that is unique to the asset and can be eliminated when combined in a portfolio of risky assets. As for our statement, we CANNOT totally eliminate uncertainty of returns just by increasing the number of risky assets that make up the portfolio: although we can eliminate unnecessary or unsystematic risk, we cannot eliminate systematic risk through diversification. Therefore, we cannot realize a riskfree investment with greater than riskfree returns.
Diff: 2
Topic: 8.7 Diversification: Minimizing Risk or Uncertainty
AACSB: 3 Analytical Thinking
LO: 8.7 Understand when and why diversification works at minimizing risk and understand the difference between systematic and unsystematic risk.
8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
1) The measure of systematic risk is called ________.
 A) correlation
 B) covariance
 C) variance
 D) beta
Answer: D
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
2) Which of the following is NOT a definition of beta?
 A) A measure of systematic risk
 B) A measure of risk that can be avoided
 C) A statistical measure of an individual asset's or portfolio's comovement with the returns of the market
 D) A measure of nondiversifiable risk
Answer: B
Explanation: B) Beta is a measurement of systematic risk, which cannot be avoided.
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
3) A beta of 1.0 is the beta of the ________, while a beta of 0.0 is the measure for a ________.
 A) riskfree security; single security held on its own.
 B) market; single security held on its own.
 C) riskfree security; market.
 D) market; riskfree security.
Answer: D
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
4) Joel owns the following portfolio of securities. What is the beta for the portfolio?
Company 
Beta 
Percent of Portfolio 
ExxonMobil 
.95 
40% 
Pacific Industries 
1.20 
35% 
Payson Restaurants 
1.35 
25% 
 A) 0.9500
 B) 1.0000
 C) 1.1375
 D) 1.1705
Answer: C
Explanation: C) βp = Σ βi ∗ wi = .95 ∗ 40% + 1.20 ∗ 35% + 1.35 ∗ 25% = 1.14.
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.
5) Kip owns the following portfolio of securities. What is the beta for the portfolio?
Company 
Beta 
Percent of Portfolio 
Apple 
.82 
50% 
Ford 
2.53 
30% 
Federal Express 
1.67 
20% 
 A) 1.00
 B) 1.50
 C) 1.74
 D) 1.98
Answer: B
Explanation: B) βp = Σ βi ∗ wi = .82 ∗ 50% + 2.53 ∗ 30% + 1.67 ∗ 20% = 1.50.
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
6) Treasury bills have a beta of ________.
 A) 0.0
 B) 0.50
 C) 1.00
 D) The beta for a Treasury bill will vary from period to period.
Answer: A
Diff: 1
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
7) John has a portfolio consisting of equal proportions of 5 securities. Susan also has a portfolio of the same five securities but the weights of each security are not equal. Which of the statements below MUST be true?
 A) Because Susan has an unequal distribution of securities, her portfolio beta must be less than John's.
 B) Without additional information, we cannot be certain whose portfolio beta is greater.
 C) Because Susan has an unequal distribution of securities, her portfolio beta must be greater than John's.
 D) Because the portfolios contain the same securities, the beta of each portfolio must be the same.
Answer: B
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
8) Beta is ________.
 A) a measure of systematic risk
 B) a measure of nondiversifiable risk
 C) the appropriate measure of risk for a welldiversified portfolio
 D) All of the above
Answer: D
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
9) Richard owns the following portfolio of securities. What is the beta for the portfolio?
Company 
Beta 
Percent of Portfolio 
Apple 
2.50 
25% 
Wells Fargo 
0.65 
50% 
eBay 
1.70 
25% 
 A) 1.00
 B) 0.65
 C) 1.62
 D) 1.38
Answer: D
Explanation: D) βp = Σ βi ∗ wi = 2.5 ∗ 25% + .65 ∗ 50% + 1.70 ∗ 25% = 1.38.
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
10) The beta of a portfolio is the weighted average of the betas of all of the assets in the portfolio.
Answer: TRUE
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
11) Bob and Mary own the same assets in each of their portfolios. Each has a different allocation of their investments across the various securities contained in the portfolio. The portfolios of Bob and Mary must have equal betas because they are investing in the same securities, just in different proportions.
Answer: FALSE
Explanation: Portfolio betas are the weighted average of the individual asset betas that comprise the portfolio. If you change the weights, you could change the portfolio beta.
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
12) Explain the difference in the two main measures of risk: the standard deviation and the beta.
Answer: It is best to use the standard deviation when describing the risk of an isolated stock or even a portfolio that is not welldiversified. It is best to use the beta of a stock to describe its risk when it is not isolated but is instead a part of a welldiversified portfolio. When it is mixed with other stocks, its fluctuations will cancel out some of the other stocks' fluctuations, thereby reducing the overall volatility of the portfolio. So a stock that looks risky by itself may very well make your portfolio safer, depending on its correlation with all the other stocks in your portfolio.
Diff: 2
Topic: 8.8 Beta: The Measure of Risk in a WellDiversified Portfolio
AACSB: 3 Analytical Thinking
LO: 8.8 Explain beta as a measure of risk in a welldiversified portfolio.
8.9 The Capital Asset Pricing Model and the Security Market Line
1) Which of the following assumptions about the Security Market Line is NOT true?
 A) There is a basic reward for waiting: the riskfree rate.
 B) The greater the risk, the greater the expected return.
 C) There is an inconsistent tradeoff between risk and reward at all levels of risk.
 D) All of the above statements are true.
Answer: C
Explanation: C) There is a CONSISTENT tradeoff between risk and reward at all levels of risk.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 1 Written and Oral Communication
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
2) The ________ is the intercept on the Security Market Line.
 A) prime rate
 B) riskfree rate
 C) market rate of return
 D) beta
Answer: B
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
3) The Security Market Line has ________.
 A) a positive slope
 B) a negative slope
 C) no slope
 D) a beta of 1.0
Answer: A
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
4) The Security Market Line ________.
 A) is curvilinear and upward sloping
 B) is curvilinear and downward sloping
 C) may curve up or down depending upon market conditions
 D) is a straight line
Answer: D
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
5) If the equation E(ri) = rf + (rf + [E(rm)  rf] × βi) is the linear equation for the Security Market Line, what portion represents the market risk premium for a stock that does not have a beta of 1.0?
 A) βi
 B) [E(rm)  rf]
 C) rf
 D) βi∗ [E(rm)  rf]
Answer: B
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
6) Assume the following information about the market and JumpMasters' stock.
JumpMasters' beta = 1.50, the riskfree rate is 3.50%, the market risk premium is 10.0%. Using the SML, what is the expected return for JumpMasters' stock?
 A) 7.50%
 B) 13.50%
 C) 18.50%
 D) 27.00%
Answer: C
Explanation: C) The equation for the SML is E(ri) = rf + (rf + [E(rm)  rf] × βi)
= 3.50% + 1.50 ∗ (13.50%  3.50%) = 18.50%.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
7) Given an expected market return of 12.0%, a beta of 0.75 for Benson Industries, and a riskfree rate of 4.0%, what is the expected return for Benson Industries?
 A) 13.0%
 B) 10.0%
 C) 9.0%
 D) 4.0%
Answer: B
Explanation: B) The equation for the SML is E(ri) = rf + (rf + [E(rm)  rf] × βi)
= 4.00% + 0.75 ∗ (12.00%  4.00%) = 10.00%.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
8) Both assets A and B plot on the SML. Asset A has an expected return of 15% and a beta of 1.7. Asset B has an expected return of 12% and a beta of 1.1. What is the slope of the security market line?
 A) 5.0%
 B) 6.5%
 C) 11.5%
 D) cannot be determined from this information.
Answer: A
Explanation: A) slope = = = = 5%.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
9) Both assets A and B plot on the SML. Asset A has an expected return of 15% and a beta of 1.7. Asset B has an expected return of 12% and a beta of 1.1. What is the riskfree rate of return?
 A) 5.0%
 B) 6.5%
 C) 11.5%
 D) It cannot be determined from this information.
Answer: B
Explanation: B) slope = = = = 5%. E(ra) = rf + (βa) × (E(rm)  rf)
(E(rm)  rf) = 5% from above; therefore, rf = E(ra)  βa(5%) = 15%  1.7 × (5%) = 6.50%.
Diff: 3
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
10) Both assets A and B plot on the SML. Asset A has an expected return of 15% and a beta of 1.7. Asset B has an expected return of 12% and a beta of 1.1. What is the expected return on the market portfolio?
 A) 5.0%
 B) 6.5%
 C) 11.5%
 D) It cannot be determined from this information.
Answer: C
Explanation: C) slope = = = = 5%. E(ra) = rf + (βa) × (E(rm)  rf)
(E(rm)  rf) = 5% from above, therefore, rf = E(ra)  βa(5%) = 15%  1.7 × (5%) = 6.50%.
E(Rm) = the market risk premium + rf = 5% + 6.5% = 11.5%.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
11) Both assets B and C plot on the SML. Asset B has a beta of 1.3 and an expected return of 13.1%. Asset C has a beta of .50 and an expected return of 7.50%. The riskfree rate is 4% and the expected return on the market portfolio is 11%. If you wish to hold a portfolio consisting of assets B and C, and have a portfolio beta equal to 1.0, what proportion of the portfolio must be in asset B?
 A) 0.375
 B) 0.50
 C) 0.625
 D) 0.75
Answer: C
Explanation: C) βP = w ∗ βB + (1  w) ∗ βC = 1.0 = w ∗ 1.3 + (1  w) ∗ 0.50, w = 0.625.
Diff: 3
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
12) Both assets B and C plot on the SML. Asset B has a beta of 1.3 and an expected return of 13.1%. Asset C has a beta of 0.50 and an expected return of 7.50%. The riskfree rate is 4% and the expected return on the market portfolio is 11%. If you wish to hold a portfolio consisting of assets B and C, and have a portfolio beta equal to 1.0, what proportion of the portfolio must be in asset C?
 A) 0.375
 B) 0.50
 C) 0.625
 D) 0.75
Answer: A
Explanation: A) βP = w ∗ βB + (1  w) ∗ βC = 1.0 = w ∗ 1.3 + (1  w) ∗ 0.50, w = 0.375.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
13) Both assets B and C plot on the SML. Asset B has a beta of 1.3 and an expected return of 13.1%. Asset C has a beta of .50 and an expected return of 7.50%. The riskfree rate is 4%. If you wish to hold a portfolio consisting of assets B and C, and have a portfolio beta equal to 1.0, what is the expected return of the portfolio?
 A) 4.0%
 B) 7.5%
 C) 11.0%
 D) 13.1%
Answer: C
Explanation: C) slope = = = = 7.0%.
Next, add this to the riskfree rate of 4% and you get a market return of 11% and a beta of 1.0.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
14) The intercept of the security market line is the rewardtorisk ratio for taking on units of systematic risk.
Answer: FALSE
Explanation: The SLOPE of the security market line is the rewardtorisk ratio for taking on units of systematic risk.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
15) If we examine the security market line, we see that the market risk premium is the riskfree rate minus the expected return on the market portfolio.
Answer: FALSE
Explanation: The market risk premium is the expected return on the market portfolio minus the riskfree rate.
Diff: 1
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
16) According to the security market line, there is no reward for waiting. In other words, in order to have any expected return at all, an investor must invest in risky assets.
Answer: FALSE
Explanation: According to the security market line, there is a reward for waiting. The riskfree asset can provide you with a positive return without uncertainty of return.
Diff: 1
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
17) What is the equation for the Security Market Line? Define each term. If an asset has a beta of 2.0, what type of return should it realize compared to the market portfolio?
Answer: The equation for the SML is E(ri) = rf + [E(rm)  rf] × βi, where: E(ri) is the expected return on an asset, rf is the riskfree rate, βi is beta the measure of nondiversifiable risk for asset i, E(rm) is the expected return for holding the market portfolio of risky assets, and [E(rm)  rf] is the market risk premium that an investor can expect to earn for holding the market portfolio. If an asset has a beta of 2.0, an investor can expect to receive twice the market risk premium in addition to the riskfree rate of return. A common misconception is that the investor can expect to receive twice the rate of return as the market portfolio, but only the risk premium is impacted by the level of risk.
Diff: 2
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.
18) Assume that both Apple and Yahoo plot on the SML. Apple has a beta of 2.6 and an expected return of 21.2%. Yahoo has a beta of 0.90 and an expected return of 9.3%. The expected return on the market portfolio is 10%and the riskfree rate is 3%. If you wish to hold a portfolio consisting of Apple and Yahoo and have a portfolio beta equal to 1.5, what proportion of the portfolio must be in Apple? What is the expected return on the portfolio?

Apple 
Yahoo 
Market Portfolio 
Riskfree Asset 
Beta 
2.6 
0.9 
1.0 
0.0 
Expected Return 
21.2% 
9.3% 
10.0% 
3.0% 
Answer:
βp = Σ βi ∗ wi =
1.50 = 2.6 ∗ wa + 0.9 * (1wa)
.60 = 1.7wa
wa = 0.6/1.7 = 0.353 and wy = 0.647
E(rp) = rf + β[E(rm)  rf] × βp = 3.0% + 1.50 ∗ [10.0%  3.0%] × 1.50 = 13.5%
Diff: 3
Topic: 8.9 The Capital Asset Pricing Model and the Security Market Line
AACSB: 3 Analytical Thinking
LO: 8.9 Illustrate how the security market line and the capital asset pricing model represent the twoparameter world of risk and return.

Key Contents: Financial Management and Corporate Finance

Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University
Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business, University of Western Ontario
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown
International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick, Columbia University

Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University
Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University, Jarrad Harford, University of Washington

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017
Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016
Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University
Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown, Virginia Polytechnic Instit. and State University
Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin
Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter

Part 1: Fundamental Concepts and Basic Tools of Finance
1. Financial Management
2. Financial Statements
3. The Time Value of Money (Part 1)
4. The Time Value of Money (Part 2)
5. Interest Rates
Part 2: Valuing Stocks and Bonds and Understanding Risk and Return
6. Financial Management Bonds and Bond Valuation
7. Stocks and Stock Valuation
8. Risk and Return
Part 3: Capital Budgeting
9: Capital Budgeting Decision Models
10: Cash Flow Estimation
11: The Cost of Capital
Part 4: Financial Planning and Evaluating Performance
12. Forecasting and ShortTerm Financial Planning
13. Working Capital Management
14. Financial Ratios and Firm Performance
Part 5: Other Selected Finance Topics
15. Raising Capital
16. Capital Structure
17. Dividends, Dividend Policy, and Stock Splits
18. International Financial Management
Appendix 1 Future Value Interest Factors
Appendix 2 Present Value Interest Factors
Appendix 3 Future Value Interest Factors of an Annuity
Appendix 4 Present Value Interest Factors of an Annuity
Appendix 5 Answers to Prepping for Exam Questions

1. Overview of Financial Management
2. Sizing Up a Business: A NonFinancial Perspective
3. Understanding Financial Statements
4. Measuring Financial Performance
5. Managing DayToDay Cash Flow
6. Projecting Financial Requirements and Managing Growth
7. Time Value of Money Basics and Applications
8. Making Investment Decisions
9. Overview of Capital Markets: LongTerm Financing Instruments
10. Assessing the Cost of Capital: What Investors Require
11. Understanding Financing and Payout Decisions
12. Designing an Optimal Capital Structure
13. Measuring and Creating Value
14. Comprehensive Case Study: WalMart Stores, Inc.
1. Overview of Financial Management
• 1.1: Financial Management and the Cash Flow Cycle
• 1.2: The Role of Financial Managers
• 1.3: A NonFinancial Perspective of Financial Management
• 1.4: Financial Management’s Relationship with Accounting and Other Disciplines
• 1.5: Types of Firms
• 1.6: A Financial Management Framework
• 1.7: Relevance for Managers
• 1.8: Summary
• 1.9: Additional Readings
• 1.10: End of Chapter Problems
2. Sizing Up a Business: A NonFinancial Perspective
• 2.1: Sizing Up The Overall Economy
o 2.1.1: GDP Components
o 2.1.2: SectorRelated Fluctuations
o 2.1.3: Inflation and Interest Rates
o 2.1.4: Capital Markets
o 2.1.5: Economic SizeUp Checklist
• 2.2: Sizing Up the Industry
o 2.2.1: Industry Life Cycles
o 2.2.2: The Competitive Environment
o 2.2.3: Opportunities and Risks
o 2.2.4: Industry Sizeup Checklist
• 2.3: Sizing Up Operations Management and Supply Risk
• 2.4: Sizing Up Marketing Management and Demand Risk
• 2.5: Sizing Up Human Resource Management and Strategy
• 2.6: Sizing Up Home Depot: An Example
• 2.7: Relevance for Managers
• 2.8 Summary
• 2.9: Additional Readings and Information
• 2.10: End of Chapter Problems
3. Understanding Financial Statements
• 3.1: Understanding Balance Sheets
o 3.1.1: Understanding Assets
o 3.1.2: Understanding Liabilities
o 3.1.3: Understanding Equity
• 3.2: Understanding Income Statements
o 3.2.1: Understanding Revenues, Costs, Expenses, and Profits
o 3.2.2: Connecting a Firm’s Income Statement and Balance Sheet
• 3.3: Understanding Cash Flow Statements
o 3.3.1: Cash Flows Related to Operating Activities
o 3.3.2: Cash Flows from Investing Activities
o 3.3.3: Cash Flows from Financing Activities
• 3.4: Relevance for Managers
• 3.5: Summary
• 3.6: Additional Readings and Sources of Information
• 3.7: End of Chapter Problems
4. Measuring Financial Performance
• 4.1: Performance Measures
o 4.1.1: Return on Equity
o 4.1.2: Profitability Measures
o 4.1.3: Resource Management Measures
o 4.1.4: Liquidity Measures
o 4.1.5: Leverage Measures
o 4.1.6: Application: Home Depot
• 4.2: Reading Annual Reports
• 4.3: Relevance for Managers
• 4.4: Summary
• 4.5: Additional Readings and Sources of Information
• 4.6: End of Chapter Problems
5. Managing DayToDay Cash Flow
• 5.1: Cash Flow Cycles
• 5.2: Working Capital Management
o 5.2.1: Managing Inventory
o 5.2.2: Managing Accounts Receivable
o 5.2.3: Managing Accounts Payable
o 5.2.4: Application: Home Depot
• 5.2.4.1: Orange Computers and Little Orange Computers
• 5.2.4.2: Home Depot
• 5.3: ShortTerm Financing
o 5.3.1: Bank Loans
o 5.3.2: Commercial Paper
o 5.3.3: Banker’s Acceptance
• 5.4: Relevance for Managers
• 5.5: Summary
• 5.6: Additional Readings
• 5.7: End of Chapter Problems
6. Projecting Financial Requirements and Managing Growth
• 6.1: Generating Pro Forma Income Statements
o 6.1.1: Establishing the Cost of Goods Sold and Gross Profit
o 6.1.2: Establishing Expenses
o 6.1.3: Establishing Earnings
• 6.2: Generating Pro Forma Balance Sheets
o 6.2.1: Establishing Assets
o 6.2.2: Establishing Liabilities and Equity
• 6.3: Generating Pro Forma Cash Budgets
o 6.3.1: Establishing Cash Inflows
o 6.3.2: Establishing Cash Outflows
o 6.3.3: Establishing Net Cash Flows
• 6.4: Performing Sensitivity Analysis
o 6.4.1: Sales Sensitivity
o 6.4.1: Interest Rate Sensitivity
o 6.4.3: Working Capital Sensitivity
• 6.5: Understanding Sustainable Growth and Managing Growth
• 6.6: Relevance for Managers
• 6.7: Summary
• 6.8: Additional Readings and Resources
• 6.9: Problems
7. Time Value of Money Basics and Applications
• 7.1: Exploring Time Value of Money Concepts
o 7.1.1: Future Values
o 7.1.2: Present Values
o 7.1.3: Annuities
o 7.1.4: Perpetuities
• 7.2: Applying Time Value of Money Concepts to Financial Securities
o 7.2.1: Bonds
o 7.2.2: Preferred Shares
o 7.2.3: Common Equity
• 7.3: Relevance for Managers
• 7.4: Summary
• 7.5: Additional Readings
• 7.6: End of Chapter Problems
8. Making Investment Decisions
• 8.1: Understanding the DecisionMaking Process
• 8.2: Capital Budgeting Techniques
o 8.2.1: Payback
• 8.2.1.1: Strengths and Weaknesses of the Payback Method
o 8.2.2: Net Present Value
• 8.2.2.1: Strengths and Weaknesses of the Net Present Value Method
o 8.2.3: Internal Rate of Return
• 8.2.3.1: Strengths and Weaknesses of the Internal Rate of Return Method
• 8.2.3.2: Modified Internal Rate of Return
• 8.3: Capital Budgeting Extensions
o 8.3.1: Profitability Index
o 8.3.2: Equivalent Annual Cost and Project Lengths
o 8.3.3: Mutually Exclusive Projects and Capital Rationing
• 8.4: Relevance for Managers
• 8.5: Summary
• 8.6: Additional Readings
• 8.7: End of Chapter Problems
9. Overview of Capital Markets: LongTerm Financing Instruments
• 9.1: Bonds
o 9.1.1: Changing Bond Yields
o 9.1.2: Bond Features
o 9.1.3: Bond Ratings
• 9.2: Preferred Shares
• 9.3: Common Shares
o 9.3.1: Historical Returns
• 9.4: Capital Markets Overview
o 9.4.1: Private versus Public Markets
o 9.4.2: Venture Capital and Private Equity
o 9.4.3: Initial Offerings versus Seasoned Issues
o 9.4.4: Organized Exchanges versus OverTheCounter Markets
o 9.4.5: Role of Intermediaries
• 9.5: Market Efficiency
o 9.5.1: Weak Form
o 9.5.2: Semistrong Form
o 9.5.3: Strong Form
o 9.5.4: U.S. Stock Market Efficiency
• 9.6: Relevance for Managers
• Appendix: Understanding Bond and Stock Investment Information
• 9.7: Summary
• 9.8: Additional Readings
• 9.9: End of Chapter Problems
10. Assessing the Cost of Capital: What Investors Require
• 10.1: Understanding the Cost of Capital: An Example
• 10.2: Understanding the Implications of the Cost of Capital
• 10.3: Defining Risk
• 10.4: Estimating the Cost of Debt
• 10.5: Estimating the Cost of Preferred Shares
• 10.6: Estimating the Cost of Equity
o 10.6.1: Dividend Model Approach
o 10.6.2: Capital Asset Pricing Model
• 10.6.2.1: RiskFree Rate
• 10.6.2.2: Market Risk Premium
• 10.6.2.3: Beta
• 10.7: Estimating Component Weights
• 10.8: Home Depot Application
• 10.9: Hurdle Rates
• 10.10: Relevance for Managers
• 10.11: Summary
• 10.12: Additional Readings
• 10.13: Problems
11. Understanding Financing and Payout Decisions
• 11.1: Capital Structure Overview
• 11.2: Understanding the ModiglianiMiller Argument: Why Capital Structure Does Not Matter
• 11.3: Relaxing the Assumptions: Why Capital Structure Does Matter
o 11.3.1: Understanding the Impact of Corporate Taxes
o 11.3.2: Understanding the Impact of Financial Distress
o 11.3.3: Combining Corporate Taxes and Financial Distress Costs
o 11.3.4: Impact of Asymmetric Information
• 11.4: Understanding Payout Policies
o 11.4.1: Paying Dividends
o 11.4.2: Repurchasing Shares
o 11.4.3: Do Dividend Policies Matter?
• 11.5: Relevance for Managers
• 11.6: Summary
• 11.7: Additional Resources
• 11.8: End of Chapter Problems
• Appendix: Why Dividend Policy Doesn’t Matter: Example
12. Designing an Optimal Capital Structure
• 12.1: Factor Affecting Financing Decisions: The FIRST Approach
o 12.1.1: Maximizing Flexibility
o 12.1.2: Impact on EPS: Minimizing Cost
• 12.1.2.1: A Simple Valuation Model
• 12.1.2.2: Earnings before Interest and Taxes BreakEven: What Leverage Really Means
• 12.1.2.3: Does Issuing Equity Dilute the Value of Existing Shares?
o 12.1.3: Minimizing Risk
o 12.1.4: Maintaining Shareholder Control
o 12.1.5: Optimal Training
• 12.2: Tradeoff Assessment: Evaluating FIRST Criteria
• 12.3: Relevance for Managers
• 12.4: Summary
• 12.5: Additional Resource
• 12.6: End of Chapter Problems
13. Measuring and Creating Value
• 13.1: An Overview of Measuring and Creating Value
• 13.2: Measuring Value: The Book Value Plus Adjustments Method
o 13.2.1: Pros and Cons of the Book Value of Equity Plus Adjustments Method
• 13.3: Measuring Value: The Discount Cash Flow Analysis Method
o 13.3.1: Estimating Free Cash Flows
o 13.3.2: Estimating the Cost of Capital
o 13.3.3: Estimating the Present Value of Free Cash Flows
o 13.3.4: Estimating the Terminal Value
o 13.3.5: Estimating the Value of Equity
o 13.3.6: Pros and Cons of the Free Cash Flow to the Firm Approach
• 13.4: Measuring Value: Relative Valuations and Comparable Analysis
o 13.4.1: The PriceEarnings Method
• 13.4.1.1: Pros and Cons of the PriceEarnings Approach
o 13.4.2: The Enterprise ValuetoEBITDA Method
• 13.4.2.1: Pros and Cons of the EV/EBITDA Approach
• 13.5: Creating Value and ValueBased Management
• 13.6: Valuing Mergers and Acquisitions
o 13.6.1: Valuing Comparable M&A Transactions
• 13.7: Relevance for Managers
• 13.8: Summary
• 13.9: Additional Readings
• 13.10: End of Chapter Problems
14. Comprehensive Case Study: WalMart Stores, Inc.
• 14.1: Sizing Up WalMart
o 14.1.1: Analyzing the Economy
o 14.1.2: Analyzing the Industry
o 14.1.3: Analyzing Walmart’s Strengths and Weaknesses in Operations, Marketing, Management, and Strategy
• 14.1.3.1: Analyzing Walmart’s Operations
• 14.1.3.2: Analyzing Walmart’s Marketing
• 14.1.3.3: Analyzing Walmart’s Management and Strategy
o 14.1.4: Analyzing Walmart’s Financial Health
• 14.2: Projecting Walmart’s Future Performance
o 14.2.1: Projecting Walmart’s Income Statement
o 14.2.2: Projecting Walmart’s Balance Sheet
o 14.2.3: Examining Alternate Scenarios
• 14.3: Assessing Walmart’s LongTerm Investing and Financing
o 14.3.1: Assessing Walmart’s Investments
o 14.3.2: Assessing Walmart’s Capital Raising and the Cost of Capital
• 14.4: Valuing Walmart
o 14.4.1: Measuring Walmart’s Economic Value Added
o 14.4.2: Estimating Walmart’s Intrinsic Value: The DCF Approach
o 14.4.3: Estimating Walmart’s Intrinsic Value: Comparable Analysis
o 14.4.4: Creating Value and Overall Assessment of Walmart
• 14.5: Relevance for Managers and Final Comments
• 14.6: Additional Readings and Sources of Information
• 14.7: End of Chapter Problems

Part 1: Introduction to Financial Management
Chapter 1: Getting Started  Principles of Finance
Chapter 2: Firms and the Financial Market
Chapter 3: Understanding Financial Statements, Taxes, and Cash Flows
Chapter 4: Financial Analysis  Sizing Up Firm Performance
Part 2: Valuation of Financial Assets
Chapter 5: Time Value of Money  The Basics
Chapter 6: The Time Value of Money  Annuities and Other Topics
Chapter 7: An Introduction to Risk and Return  History of Financial Market Returns
Chapter 8: Risk and Return  Capital Market Theory
Chapter 9: Debt Valuation and Interest Rates
Chapter 10: Stock Valuation
Part 3: Capital Budgeting
Chapter 11: Investment Decision Criteria
Chapter 12: Analyzing Project Cash Flows
Chapter 13: Risk Analysis and Project Evaluation
Chapter 14: The Cost of Capital
Part 4: Capital Structure & Dividend Policy
Chapter 15: Capital Structure Policy
Chapter 16: Dividend Policy
Part 5: Liquidity Management & Special Topics in Finance
Chapter 17: Financial Forecasting and Planning
Chapter 18: Working Capital Management
Chapter 19: International Business Finance
Chapter 20: Corporate Risk Management

PART I: INTRODUCTION TO FOREIGN EXCHANGE MARKETS AND RISKS
Chapter 1: Globalization and the Multinational Corporation
Chapter 2: The Foreign Exchange Market
Chapter 3: Forward Markets and Transaction Exchange Risk
Chapter 4: The Balance of Payments
Chapter 5: Exchange Rate Systems
PART II: INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE DETERMINATION
Chapter 6: Interest Rate Parity
Chapter 7: Speculation and Risk in the Foreign Exchange Market
Chapter 8: Purchasing Power Parity and Real Exchange Rates
Chapter 9: Measuring and Managing Real Exchange Risk
Chapter 10: Exchange Rate Determination and Forecasting
PART III: INTERNATIONAL CAPITAL MARKETS
Chapter 11: International Debt Financing
Chapter 12: International Equity Financing
Chapter 13: International Capital Market Equilibrium
Chapter 14: Political and Country Risk
PART IV: INTERNATIONAL CORPORATE FINANCE
Chapter 15: International Capital Budgeting
Chapter 16: Additional Topics in International Capital Budgeting
Chapter 17: Risk Management and the Foreign Currency Hedging Decision
Chapter 18: Financing International Trade
Chapter 19: Managing Net Working Capital
PART V: FOREIGN CURRENCY DERIVATIVES
Chapter 20: Foreign Currency Futures and Options
Chapter 21: Interest Rate and Foreign Currency Swaps

PART 1: INTRODUCTION
1. The Corporation
2. Introduction to Financial Statement Analysis
3. Financial Decision Making and the Law of One Price
PART 2: TIME, MONEY, AND INTEREST RATES
4. The Time Value of Money
5. Interest Rates
6. Valuing Bonds
PART 3: VALUING PROJECTS AND FIRMS
7. Investment Decision Rules
8. Fundamentals of Capital Budgeting
9. Valuing Stocks
PART 4: RISK AND RETURN
10. Capital Markets and the Pricing of Risk
11. Optimal Portfolio Choice and the Capital Asset Pricing Model
12. Estimating the Cost of Capital
13. Investor Behavior and Capital Market Efficiency
PART 5: CAPITAL STRUCTURE
14. Capital Structure in a Perfect Market
15. Debt and Taxes
16. Financial Distress, Managerial Incentives, and Information
17. Payout Policy
PART 6: ADVANCED VALUATION
18. Capital Budgeting and Valuation with Leverage
19. Valuation and Financial Modeling: A Case Study
PART 7: OPTIONS
20. Financial Options
21. Option Valuation
22. Real Options
PART 8: LONGTERM FINANCING
23. Raising Equity Capital
24. Debt Financing
25. Leasing
PART 9: SHORTTERM FINANCING
26. Working Capital Management
27. ShortTerm Financial Planning
PART 10: SPECIAL TOPICS
28. Mergers and Acquisitions
29. Corporate Governance
30. Risk Management
31. International Corporate Finance

PART 1: INTRODUCTION
1. The Corporation
2. Introduction to Financial Statement Analysis
3. Financial Decision Making and the Law of One Price
PART 2: TIME, MONEY, AND INTEREST RATES
4. The Time Value of Money
5. Interest Rates
6. Valuing Bonds
PART 3: VALUING PROJECTS AND FIRMS
7. Investment Decision Rules
8. Fundamentals of Capital Budgeting
9. Valuing Stocks
PART 4: RISK AND RETURN
10. Capital Markets and the Pricing of Risk
11. Optimal Portfolio Choice and the Capital Asset Pricing Model
12. Estimating the Cost of Capital
13. Investor Behavior and Capital Market Efficiency
PART 5: CAPITAL STRUCTURE
14. Capital Structure in a Perfect Market
15. Debt and Taxes
16. Financial Distress, Managerial Incentives, and Information
17. Payout Policy
PART 6: ADVANCED VALUATION
18. Capital Budgeting and Valuation with Leverage
19. Valuation and Financial Modeling: A Case Study


PART 1 INTRODUCTION
Chapter 1 Corporate Finance and the Financial Manager
Chapter 2 Introduction to Financial Statement Analysis
PART 2 INTEREST RATES AND VALUING CASH FLOWS
Chapter 3 Time Value of Money: An Introduction
Chapter 4 Time Value of Money: Valuing Cash Flow Streams
Chapter 5 Interest Rates
Chapter 6 Bonds
Chapter 7 Stock Valuation
PART 3 VALUATION AND THE FIRM
Chapter 8 Investment Decision Rules
Chapter 9 Fundamentals of Capital Budgeting
Chapter 10 Stock Valuation: A Second Look
PART 4 RISK AND RETURN
Chapter 11 Risk and Return in Capital Markets
Chapter 12 Systematic Risk and the Equity Risk Premium
Chapter 13 The Cost of Capital
PART 5 LONGTERM FINANCING
Chapter 14 Raising Equity Capital
Chapter 15 Debt Financing
PART 6 CAPITAL STRUCTURE AND PAYOUT POLICY
Chapter 16 Capital Structure
Chapter 17 Payout Policy
PART 7 FINANCIAL PLANNING AND FORECASTING
Chapter 18 Financial Modeling and Pro Forma Analysis
Chapter 19 Working Capital Management
Chapter 20 ShortTerm Financial Planning
PART 8 Special Topics
Chapter 21 Option Applications and Corporate Finance
Chapter 22 Mergers and Acquisitions
Chapter 23 International Corporate Finance

FINANCIAL MANAGEMENT AND CORPORATE FINANCE  COLLECTION 2017 (FREE DOWNLOAD)
Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University
Free download  PPT  Link
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Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business
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International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick
Free download  PPT 1  Link
Free download  PPT 2  Link
Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
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Free download  PPT 2  Link
Free download  PPT 3  Link
Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University
Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo,
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown
Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017
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Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016
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Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University
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Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown,
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Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin
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Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter
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DOWNLOAD ALL TEST BANKs & CASE STUDY GUIDES  2017
Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University  Test bank
Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business  Test bank
Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University  Test bank
International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick  Test bank
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown  Test bank
Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo  Test bank
Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017  Test bank
Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016  Test bank
Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University  Test bank
Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown  Test bank
Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin  Test bank
Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter  Test bank

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