What is the market risk premium if the risk free rate is 5 percent and the expected market return is given as follows?

82. What is the market risk premium if the risk free rate is 5 percent and the expected
market return is given as follows?
State of Nature Probability Return
Boom 20% 30%
Average 70% 15%
Recession 10% -5%
(a) 10.5%
(b) 11.0%
(c) 16.0%
(d) 16.5%
Answer: B
Level of Difficulty: 3
Learning Goal: 2
Topic: Expected Return and CAPM (Equation 5.2 and 5.8)

83. Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1,2002. He received a dividend of $2.00 per share at the end of 2002 and $3.00 per shareat the end of 2003. At the end of 2004, Nico collected a dividend of $4.00 per share and sold his stock for $18.00 per share. What was Nico’s realized return during the three year holding period?

(a) –12.5%
(b) +12.5%
(c) –16.7%
(d) +16.7%
Answer: B
Level of Difficulty: 3
Learning Goal: 2
Topic: Measuring Single Asset Return (Equation 5.1)
84. Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1,
2002. He received a dividend of $2.00 per share at the end of 2002 and $3.00 per share
at the end of 2003. At the end of 2004, Nico collected a dividend of $4.00 per share and
sold his stock for $18.00 per share. What was Nico’s realized return during the three
year holding period? What was Nico’s compound annual rate of return?
(a) –12.5%; –4.4%
(b) +12.5%; +4.4%
(c) –16.7%; –4.4%
(d) +16.7%; +4.4%
Answer: B
Level of Difficulty: 4
Learning Goal: 2
Topic: Measuring Single Asset Return (Equation 5.1)
n Multiple Choice Questions
1. Equity capital can be raised through
(a) the money market.
(b) the NYSE bond market.
(c) retained earnings and the stock market.
(d) a private placement with an insurance company as the creditor.
Answer: C
Level of Difficulty: 1
Learning Goal: 1
Topic: Issuing Common Stock
2. Holders of equity capital
(a) own the firm.
(b) receive interest payments.
(c) receive guaranteed income.
(d) have loaned money to the firm.
Answer: A
Level of Difficulty: 1
Learning Goal: 1
Topic: Features of Common Stock
3. As a form of financing, equity capital
(a) has a maturity date.
(b) is only liquidated in bankruptcy.
(c) is temporary.
(d) has priority over bonds.
Answer: B
Level of Difficulty: 2
Learning Goal: 1
Topic: Features of Common Stock
4. The claims of the equity holders on income have priority over
(a) the claims of the preferred stockholders.
(b) the claims of the creditors.
(c) the claims of the unsecured creditors.
(d) no one.
Answer: D
Level of Difficulty: 2
Learning Goal: 1
Topic: Features of Common Stock
5. _________ are promised a fixed periodic dividend that must be paid prior to paying any
common stock dividends.
(a) Preferred stockholders
(b) Common stockholders
(c) Bondholders
(d) Creditors
Answer: A
Level of Difficulty: 1
Learning Goal: 2
Topic: Features of Preferred Stock
6. Dividends in arrears that must be paid to the preferred stockholders before payment of
dividends to common stockholders are
(a) cumulative.
(b) noncumulative.
(c) participating.
(d) convertible.
Answer: A
Level of Difficulty: 1
Learning Goal: 2
Topic: Features of Preferred Stock
7. An 8 percent preferred stock with a market price of $110 per share and a $100 par value
pays a cash dividend of _________.
(a) $4.00
(b) $8.00
(c) $8.80
(d) $80.00
Answer: B
Level of Difficulty: 1
Learning Goal: 2
Topic: Features of Preferred Stock
8. From the corporation’s point of view, the advantages of issuing preferred stock include
all of the following EXCEPT
(a) its increased financial leverage.
(b) its flexible dividend policy.
(c) its excellent merger security.
(d) its difficulty to retire.
Answer: D
Level of Difficulty: 1
Learning Goal: 2
Topic: Features of Preferred Stock
9. The advantages of issuing preferred stock from the common stockholder’s perspective
include all of the following EXCEPT
(a) seniority of the preferred stockholder’s claim.
(b) flexibility.
(c) use in mergers.
(d) increased leverage.
Answer: A
Level of Difficulty: 2
Learning Goal: 2
Topic: Features of Preferred Stock
10. The cost of preferred stock is
(a) lower than the cost of long-term debt.
(b) higher than the cost of common stock.
(c) higher than the cost of long-term debt and lower than the cost of common stock.
(d) lower than the cost of convertible long-term debt and higher than the cost of
common stock.
Answer: C
Level of Difficulty: 2
Learning Goal: 2
Topic: Features of Preferred Stock