Questions on Stock, Equity, Risk, Leverage,Ratios

Chapter 5

15. For the risk-seeking manager, no change in return would be required for an increase in risk.

16. For the risk-averse manager, the required return decreases for an increase in risk.

17. For the risk-indifferent manager, no change in return would be required for an increase in risk.

18. Most managers are risk-averse, since for a given increase in risk they require an increase in return.

19. The return on an asset is the change in its value plus any cash distribution over a given period of time, expressed as a percentage of its ending value.

20. The real utility of the coefficient of variation is in comparing assets that have equal expected returns.

21. An investment that guarantees its holder $100 return and another investment that earns $0 or $200 with equal chances (i.e., an average of $100) over the same period have equal risk.

Chapter 6

22. Real rate of interest is the actual rate of interest charged by the suppliers of funds and paid by the demanders.

23. The longer the maturity of a Treasury (or any other) security, the smaller the interest rate risk.

24. A downward-sloping yield curve indicates generally cheaper short-term borrowing costs than long-term borrowing costs.

25. The nominal rate of interest is the rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where funds suppliers and demanders have no liquidity preference and all outcomes are certain.

26. An inverted yield curve is an upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs.

27. Although Treasury securities have no risk of default or illiquidity, they do suffer from "maturity risk"-the risk that interest rates will change in the future and thereby impact longer maturities more than shorter maturities.

28. Liquidity preference theory suggests that for any given issuer, long-term interest rates tend to be higher than short-term rates due to the lower liquidity and higher responsiveness to general interest rate movements of longer-term securities; causes the yield curve to be upward-sloping.

Chapter 7

29. Holders of equity have claims on both income and assets that are secondary to the claims of creditors.

30. The tax deductibility of interest lowers the cost of debt financing, thereby causing the cost of debt financing to be lower than the cost of equity financing.

31. Preferred stock is a special form of stock having a fixed periodic dividend that must be paid prior to payment of any interest to outstanding bonds.

32. Cumulative preferred stocks are preferred stocks for which all passed (unpaid) dividends in arrears must be paid in additional shares of preferred stock prior to the payment of dividends to common stockholders.

33. Preferred stock is often considered a quasi-debt since it yields a fixed periodic payment.

34. The amount of the claim of preferred stockholders in liquidation is normally equal to the market value of the preferred stock.

35. Cumulative preferred stocks are not preferred stocks for which all passed (unpaid) dividends in arrears must be paid along with the current dividend prior to the payment of dividends to common stockholders.

Chapter 10

36. The breakeven cash inflow is the minimum level of cash inflow necessary for a project to be acceptable.

37. Projects with a small chance of being acceptable and a broad range of expected cash flows are more risky than projects having a high chance of being acceptable and a narrow range of expected cash flows.

38. In capital budgeting, risk refers to the chance that a project has a high degree of variability of the initial investment.

39. Sensitivity analysis is a behavioral approach that uses a number of possible values for a given variable to assess its impact on a firm's return.

40. Sensitivity analysis is a statistically based approach used in capital budgeting to get a feel for risk by applying predetermined probability distributions and random numbers to estimate risky outcomes.

41. Scenario analysis is an approach that uses a number of possible values for a given variable in order to assess its impact on a firm's return.

42. Simulation is an approach that evaluates the impact on return of simultaneous changes in a number of variables.

Chapter 12

43. Generally, increases in leverage result in increased return and risk.

44. Breakeven analysis is used by the firm to determine the level of operations necessary to cover all fixed operating costs and to evaluate the profitability associated with various levels of sales.

45. The firm's operating breakeven point is the level of sales necessary to cover all fixed operating costs.

46. Leverage results from the use of fixed-cost assets or funds to magnify returns to the firm's owners.

47. Operating leverage is concerned with the relationship between the firm's sales revenue and its operating expenses.

48. Financial leverage is concerned with the relationship between the firm's earnings after interest and taxes and its common stock earnings per share.

49. Total leverage is concerned with the relationship between the firm's sales revenue and its common stock earnings per share.

Chapter 14

50. A firm that is unable to pay its bills as they come due is technically insolvent.

51. The short-term financial management is concerned with management of the firm's current assets and current liabilities.

52. In the short-term financial management, the goal is to manage each of the firm's current assets and current liabilities in order to achieve a balance between profitability and risk that contributes to the firm's value.

53. Working capital represents the portion of the firm's investment that circulates from one form to another in the long-term conduct of business.

54. In general, the more a firm's current assets cover its short-term obligations, the better able it will be to pay its bills as they come due.

55. The more predictable its cash inflows, the more net working capital a firm needs.

56. As the ratio of current assets to total assets increases, the firm's risk increases.