,1. Multiple Choice: Which of the following is not a
component of the Weighted Average Cost of Capital
(WACC)?
a) Cost of debt
b) Market risk premium
c) Cost of equity
d) Cost of preferred stock
Answer: b) Market risk premium
Rationale: The market risk premium is not a direct
component of WACC. WACC is calculated using the costs
of all capital components (debt, equity, and preferred stock),
and the market risk premium is part of the Capital Asset
Pricing Model (CAPM) used to determine the cost of equity.
2. Fill-in-the-Blank: The __________ is the rate of return
required by investors to compensate for the risk of owning a
security.
Answer: Expected return
Rationale: The expected return is the return that investors
anticipate or demand for taking on the risk of investing in a
security. It is a fundamental concept in financial
management and valuation.
4. Multiple Response: Select all that apply. Which of the
following are assumptions of the Capital Asset Pricing
Model (CAPM)?
a) Investors have homogeneous expectations
b) There are no taxes or transaction costs
c) All assets are infinitely divisible
d) Investors can lend and borrow at the risk-free rate
Answers: a), b), c), d)
Rationale: CAPM is based on a set of theoretical
assumptions, including homogeneous expectations among
investors, no taxes or transaction costs, infinitely divisible
assets, and the ability to lend and borrow at the risk-free
rate.
5. Multiple Choice: In the context of portfolio theory,
diversification is most effective in reducing:
a) Systematic risk
b) Unsystematic risk
c) Total risk
d) Market risk
Answer: b) Unsystematic risk
Rationale: Diversification is a strategy used to reduce
unsystematic risk, which is the risk associated with
individual securities. Systematic risk, also known as market
risk, cannot be eliminated through diversification.
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