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Exam 13: Risk and Capital Budgeting

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Question 31

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The concept of being risk-averse means

A) investors don't want to take on any risk.
B) investors would usually prefer investments with high standard deviations and a greater opportunity for gain.
C) that the greater the risk, the lower the expected return must be.
D) that for a given situation, investors would prefer relative certainty to uncertainty, and the greater the risk, the higher the expected return must be.

E) A) and B)
F) A) and D)

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Question 32

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Modigliani and Associates has forecasted the following payoffs from a project: What is the expected value of the outcomes?

A) $0
B) $3,300
C) $3,700
D) Cannot be determined. Depends upon which prediction is correct.

E) C) and D)
F) None of the above

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Question 33

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The higher the risk of an investment, the lower the required rate of return by investors. The higher the risk, the higher the consequent required rate of return.

Buchanan Corp. forecasts the following payoffs from a project: What is the expected value of the outcomes?

If possible outcomes are D and probabilities are P, the standard deviation is defined as

As the time horizon becomes shorter, more uncertainty enters the forecast. The level of uncertainty increases with time.

Combining assets with highly correlated returns will greatly reduce portfolio risk. Just the opposite: Negative correlation spreads risk more effectively.

Sensitivity analysis helps the financial planner determine how sensitive shareholders will be to changes in investment strategy.

Which of the following is a characteristic of beta?

The firm's highest risk-adjusted discount should be applied to

Cyclical businesses are likely to have higher costs of capital than firms with less variability in earnings. Therefore, more cyclical firms should typically use a higher discount rate in project evaluation.

In determining the appropriate discount rate for an individual project, the financial manager will be most influenced by the

The coefficient of correlation represents the standard deviation divided by the expected value. This is actually the definition of the "coefficient of variation."

Which of the following is a common approach in dealing with uncertainty?

The cost of capital is assumed to contain no risk for the firm. As noted in earlier chapters, the cost of capital begins with a risk-free rate, but is then adjusted for inflation risk and business risk.

An investment with a $500 standard deviation and a $5,000 expected value has a higher risk than an investment with a $4,000 standard deviation and a $50,000 expected value.

A correlation coefficient of zero indicates

The measure of risk is best described as

A project's cash flows have a beta of 1.2, a standard deviation of $340, and a coefficient of variation of 0.40. What is the expected cash flow?

When choosing portfolios of assets, management should try to achieve the highest possible return at a given level of risk.