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    Risk aversion, reward-to-risk ratio and debt financing

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    42. Greater confidence in the long-run health of the economy leads to a reduced risk aversion,
    A) firms' betas will increase
    B) firms' betas will decrease
    C) investors' required return will decrease
    D) investors' required return will increase
    E) both (B) and (C)

    43. While Stock X has a reward-to-risk ratio of 6.5, Stock Y has a reward-to-risk ratio of 8.2. You know
    A) Stock X is overpriced
    B) Stock X is a better investment
    C) Stock Y is under-priced
    D) Stock is a better investment

    47. When a firm uses debt financing,
    A) it increases the required return on equity because the business risk born by its shareholders increases
    B) it decreases the required return on equity because debt financing is cheaper
    C) It decreases the WACC because the financial risk born by its shareholders decreases
    D) It increases the WACC because the business risk born by its shareholders increases
    E) none of above.

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    Solution Preview

    42. Greater confidence in the long-run health of the economy leads to a reduced risk aversion,
    A) firms' betas will increase
    B) firms' betas will decrease
    C) investors' required return will decrease
    D) investors' required return will increase
    E) both (B) and (C)

    Answer: C) investors' required return will decrease

    Security Market Line (SML) is a plot in the risk return space: It is a plot of required return versus Beta. The slope of the SML reflects the general level of risk aversion.
    If investors become more risk averse, people will demand a larger premium for bearing any level of risk (i.e. higher return for the same level of ...

    Solution Summary

    The solution provides answers Multiple Choice questions on risk aversion, reward-to-risk ratio, debt financing.

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