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77 Cards in this Set
- Front
- Back
- 3rd side (hint)
The efficient portfolios:
(I) have only unique risk (II) provide highest returns for a given level of risk (III) provide the least risk for a given level of returns (IV) have no risk at all |
One and two only
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The correlation measures the:
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Direction of movement between the returns of two stocks
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Maximum diversification is obtained by combining two stocks with a correlation coefficient equal to:
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-1.0
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Beta of the market portfolio is:
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+1.0
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Beta of Treasury bills portfolio is:
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0
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The capital asset pricing model (CAPM) states that:
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The expected risk premium on an investment is proportional to its beta
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Beta measure indicates:
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The change in the rate of return on an investment for a given change in the market return
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T F Financial leverage affects the risk of the firm's assets.
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False
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A stock with a beta of zero would be expected to:
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Have a rate of return equal to the risk-free rate
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The "beta" is a measure of:
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Market risk
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Cost of capital is the same as cost of equity for firms that are:
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financed entirely by equity
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Total capitalization is defined as:
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Total long-term liabilities plus stockholders' equity
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The market value of equity is calculated as:
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(Market price) x (# of shares outstanding)
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Modigliani and Miller's Proposition I states that:
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The market value of any firm is independent of its capital structure
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As EBIT increases for a levered firm,
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the EPS increases by a larger percent
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When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of operating income because:
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Interest payments on the debt stay fixed, leaving more income to be distributed over less shares
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T F According to Proposition II, the cost of equity increases as more debt is issued, but the weighted average cost of capital remains unchanged.
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True
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T F Financial leverage increases the expected return and risk of the shareholder.
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True
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Risk shifting implies:
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When faced with bankruptcy, managers tend to invest in high risk, high return projects
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The trade-off theory of capital structure predicts that:
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Safe firms should borrow more than risky ones
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T F Financial leverage affects the risk of the firm's common stock.
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False
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The pecking order theory of capital structure implies that:
(I) Risky firms will end up borrowing more (II) Firms prefer internal finance (III) Firms prefer debt to equity when external financing is required |
II and III only
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Corporations typically have the right to repurchase a debt issue prior to maturity at a fixed price. Such debt issues are said to be:
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Callable
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= Current Assets/Current Liabilities
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Current Ratio
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=(CA-Inventory)/CL
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Quick Ratio
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What are the two liquidity ratios?
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Current and quick
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= COGS/ Inventory
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Inventory Turnover Ratio
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=365/ (Revenue/Accts. Rec)
or Accts Rec/ (Sales/365) |
Day Sales Outstanding Ratio
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= Total Debt/(Shares outstanding*Price)
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Debt to Equity Ratio
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=(EBIT+Depreciation)/Int. Exp
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Interest Coverage Ratio
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=Net Income/Sales
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Profit Margin Ratio
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=Net Income/Total Assets
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Return on Assets ratio
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=Net Income/Total Equity
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Return on Equity ratio
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=Net Income/Shares Outstanding
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Earnings Per Share (EPS)
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=Market Price per Share/Earnings per share
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Price Earnings Ratio
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=Tax Expense/Earnings Before Taxes
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Tax Rate
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G=(1-payout ratio)* ROE
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Growth Rate. ROE = (NI/Total equity)
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Capital Gains Yield = (Pe-Pb)/Pb
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[Ending Price(Pe)-Beginning Price(Pb)]/Beginning Price (Pb)
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Dividend Yield=Div/Pb
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Dividend/Beginning price
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βA = (pA,M)σA / σM
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Beta of the Firm - Stdev(firm)*(the correlation between the returns for the firm and market)/Stdev(mkt)
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βU = βL / [1 + (1 – T)(D/E)]
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Change to:
βL = βU*[1+(1-T)(D/E)] D/E= Liabilities/Equity |
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How do you calculate the We?
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Total Equity/(Total Equity+Total Liabilities)
or (1- Wd) |
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How do you calculate the Wd?
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Total Liabilities/(Total Equity+Total Liabilities)
or (1-We) |
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How do you calculate the Kd?
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Yield to Maturity, or Given
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How do you calculate the Ke(acctg)?
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Growth Rate + [(Forecast EPS * Payout Ratio)/Price]
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How do you calculate the Ke(CAPM)?
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Krf + [Beta*(Km-Krf)]
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What is the WACC equation? Both CAPM and acctg?
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(Wd*Kd)(1-t)+(We*Ke)
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What are the leverage ratios?
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1. Debt to Equity
2. Total Debt Ratio 3. Interest Coverage Ratio |
(3)
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What are the Profitability Ratios?
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1. Profit Margin
2. Return on Equity 3. Return on Assets |
(3)
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What are 4 ways to manipulate earnings?
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Channel stuffing, Reserve accounts, options as compensation, off balance sheet items
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What is the Kd?
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Cost of Debt (interest rate)
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What did MMI State?
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That capital structure doesn't matter. It is irrevelant because assets create revenue
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What were the 3 assumptions for MMI
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1. Perfect information
2. Everyone borrows at Kfr 3. Everyone has the same tax rate |
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What did MMII state?
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Higher debt will increase tax shields - however, it is exactly counteracted by the increase in the cost of capital
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What are the 3 theories for how we see capital structure?
(why we see different levels of debt) |
1. Pecking order
2. Trade off theory 3. Agency Cost theory |
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What is the pecking order theory?
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You use the cheapest source of funds first. Usually RE, then Debt. But debt gets more expensive than Equity, so then switch again
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What is the trade off theory?
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Issue debt to get tax shields until marginal benefit of the tax shield = marginal cost of the financial distress
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What is the agency cost theory?
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Issue debt to constrain management
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What is moral hazard?
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Moral hazard is the result of maximizing behavior. A person weighs the costs and benefits of an action, and when benefits exceed costs, he takes the action.
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What are the two types of agency problems?
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Adverse Selection, Moral hazard
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What is adverse selection?
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A market process in which "bad" results occur when buyers and sellers have access to different information. The "bad" customers are likely to be selected
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What is an Agency Relationship?
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The relationship between stockholders and management
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What are the three types of ownership structures for a firm?
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1. Managerial Ownership
2. 5% shareholders/blockholders 2. Institutional Ownership |
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What are the two committies within the board of directors?
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-Compensation Committee
-Audit Committee |
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How do you calculate the Market rate?
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Market Risk Premium + Risk Free Rate
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Kd can also be equal to ____
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Krf
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What are the Leverage ratios?
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Debt to Equity
Interest Coverage Total Debt |
(3)
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How do you calculate the Debt to Equity Ratio?
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Total Debt/(Shares outstanding *price)
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How do you calculate the Interest coverage ratio?
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(EBIT+Depreciation)/ Interest Expense
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What are the Efficiency Ratios?
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Inventory Turnover
DSO |
(2)
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What are the four types of ratios?
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Liquidity
Leverage Efficiency Profitibility |
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Example of a moral hazard
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Credit card companies limiting the amount that borrowers can spend, b/c without such limits, they may spend recklessy, leading to default
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Lending institutions and moral hazard
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Lending institutions can make risky loans that will pay handsomely if the investment turns out. They will be bailed out by the taxpayer if the investment goes bad
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Reducing Adverse Selection problems through innovative pricing and product schemes:
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Insurance companies can segregate high-risk and low-risk policy holders by offering different policies with different prices
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What does a Beta of 1 mean?
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The company moves in line with the market
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What does a beta < 1 mean?
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The share is more stable
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What does a beta greater than 1 mean?
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the share is exaggerating the market movement
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