1.

Diversification works because I. unsystematic risk exists II. forming stocks into a portfolio reduces the standard deviation of each stock in the portfolio III. firm-specific risk can be dramatically reduced if not eliminated A. I only B. III only C. I and II only D. I and III only E. I, II, and III

2.

Ed Lawrence has $100,000 invested. Of that, $30,000 is invested in IBM stock, $25,000 is invested in T-bills, and the remainder is invested in corporate bonds. Which of the following is NOT correct regarding his portfolio weights? (All values are current market values.) A. Ed has 30% of his portfolio invested in stocks B. Ed has 45% of his portfolio invested in corporate bonds C. Ed has 70% of his portfolio invested in assets other than stocks D. Ed's portfolio has a beta of one E. If Ed liquidates his corporate bonds and buys GM stock with the proceeds, he will end up with 75% of his portfolio invested in stocks

3.	Asset A has an expected return of 15%. The expected market return is 14% and the risk-free rate is 4%. What is Asset A's beta? A. .50 B. .75 C. 1.1 D. 1.8 E. 2.0

4.	Anthony's Antiques, Inc. has preferred stock outstanding which pays a dividend of $4 per share a year. The current price is $32 per share. What is its cost of preferred stock? A. 8.0% B. 9.0% C. 10.0% D. 11.0% E. 12.5%

5.

Suppose you are considering a project that costs $300 and has expected cash flows of $110, $121 and $133.10 over the next three years. If the appropriate discount rate for the project's cash flows is 10%, what is the net present value of this project? A. The NPV is negative B. $0.00 C. $0.71 D. $19.79 E. $64.10

6.	What is the IRR of the following project and what is the maximum number of IRRs that may exist? YearCash Flow 0-$50,000 1-$5,000 2$50,000 3$50,000 4-$25,000 A. 0; 0 B. 16.2%; 1 C. 16.2%; 2 D. 17.1%; 1 E. 17.1%; 2

7.	What is the payback period of a $40,000 investment with the following cash flows? YearCash Flow 120,000 225,000 310,000 410,000 55,000 A. 1 year B. 1.8 years C. 2 years D. 2.25 years E. 3.5 years

8.

KCE Corporation is currently operating at its target capital structure with market values of $110,000,000 in equity and $175,000,000 in debt outstanding. KCE plans to finance a new $32 million project using the same relative weights of debt and equity. How much new debt must be issued to fund the project? A. $12.4 million B. $18.5 million C. $19.6 million D. $24.8 million E. $32.0 million

9.	Asset A has an expected return of 22% and a beta of 1.8. The expected market return is 14%. What is the risk-free rate? A. 0.6% B. 1.2% C. 3.0% D. 4.0% E. 6.0%

10.	Your required return is 15%. Should you accept a project with the following cash flows? YearCash Flow 0-$85 140 240 335 A. No, because the IRR is 13.9% B. No, because the IRR is 14.7% C. Yes, because the IRR is 16.19% D. Yes, because the IRR is 17.2% E. Yes, because the IRR is 19.2%

11.

You are considering two investments. You note that the return on investment A tends to vary quite widely from its average, definitely more so than investment B does. Based on this you believe that A. A has a lower variance than B B. A has a lower standard deviation than B C. A has a higher inflation premium than B D. A has a higher return volatility than B E. A must be stock in one of the 500 largest U.S. firms while B must be stock in one of the smallest firms listed on the NYSE

12.	Which of the following formulas correctly describes the cost of equity capital? A. R*BE = D*B0 /P*B0 + g B. R*BE = D*B1 + g/P*B0 C. R*BE = D*B1 /P*B0 + g D. R*BE = R*Bf - b ´ (R*Bf - R*Bm ) E. R*BE = R*Bf + b ´ (R*Bm + R*Bf )

13.	Rattle me Bones, Inc.'s common stock is currently selling for $66.25 per share. You expect the next dividend to be $5.30 per share. If the firm has a dividend growth rate of 4%, what is its cost of equity? A. 12.0% B. 12.3% C. 13.5% D. 13.9% E. 14.1%

14.	Given the following information, what is the average annual dividend growth rate? YearDividend 19912.50 19922.60 19932.65 19942.78 19952.89 19963.05 A. 3.0% B. 3.8% C. 4.0% D. 4.6% E. 5.4%

15.	Treasury bills currently have a return of 3.5% and the market risk premium is 8%. If a firm has a beta of 1.6, what is its cost of equity? A. 8.8% B. 10.7% C. 12.8% D. 16.3% E. 18.8%

16.	Rattle me Bones, Inc. sold a 20-year bond issue 12 years ago. It pays an 8% annual coupon and has a $1,000 face value. If the current price per bond is $893.30, what is the firm's cost of debt? A. 8.0% B. 9.2% C. 9.5% D. 10.0% E. 10.5%

17.	You purchased a bond on January 1 that has a $1000 face value and an 8% annual coupon. You paid $839.67 and you can sell the bond for $842.33 on December 31. What is your total dollar return for the year? A. $2.66 B. $10.66 C. $72.66 D. $77.34 E. $82.66

18.	You purchased 200 shares of preferred stock on January 1 for $42.27 per share. The stock pays an annual dividend of $5 per share. On December 31, the market price is $43.88 per share. What is your percentage return for the year if you hold on to the stock? A. 4.9% B. 8.0% C. 14.9% D. 15.1% E. 15.6%

19.	Given the following historical returns, what is the variance? Year 1 = 8%; year 2 = -12%; year 3 = 6%; year 4 = 1%; and year 5 = -19%. A. .0063 B. .0089 C. .0139 D. .0394 E. .1178

20.	Which form(s) of market efficiency is (are) generally considered to hold in well-organized markets? I. Strong-form efficiency II. Semistrong-form efficiency III. Weak-form efficiency A. I only B. II only C. III only D. I and II only E. II and III only

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