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principles corporate finance
Questions and Answers of
Principles Corporate Finance
The β coefficient measures the specific risk of a security. True or false?
Is the Heineken share more or less risky than the whole of the market? Why?
Upon what is the β coefficient dependent?
Why are market risk and specific risk totally independent?
Will an increase in a company’s debt reduce or increase the volatility of its share price?
As a result of a change in the nature of its business, there is a relative rise in the proportion of fixed costs in a group A’s total costs. Will this affect the risk attached to its share price?
Explain why it is unhealthy for a company to invest its cash in shares.
Is the β of a diversified conglomerate close to 1? Why?
Internet companies have low fixed costs and low debt levels, yet their β coefficients are high. Why?
Is the β coefficient of a group necessarily stable over time? Why?
You buy a lottery ticket for BC100 on which you could win BC1,000,000, with a probability rate of 0.008%. Is this a risky investment? Could it be even riskier? How could you reduce the risk? Would
Why is standard deviation preferable to variance?
What law of statistics explains that in the long term, risk disappears? State your views.
You receive BC100,000 which you decide to save for your old age. You are now 20. What sort of investment should you go for? Perform the same analysis as if it happened when you are 55 and 80.
Do shares in Internet companies carry a greater or smaller risk than shares in large retail groups? Why?
There are some sceptics who claim that financial analysis serves no purpose. Why?State your views.
Why are negative β coefficients unusual?
What can you say about a share for which the standard deviation of the return is high, and the β is low?
Must the values of financial assets fluctuate in opposite directions in order to reduce risk? Why?
What other concept does the capital market line bring to mind?
Why does the market portfolio include all high risk assets in order to achieve maximum diversification?
Security A carries little risk and security B has great risk. Which would you choose if you wanted to take the least risk possible?
The correlation coefficient between French equities and European equities developed as follows: Years 1970-1979 1980-1989 1990-1999 2000-2008 Coefficient 0.43 0.42 0.73 0.996
Use the table on page 400 to determine which industrial sector makes the greatest contribution to reducing the risk of a portfolio.
What is the only asset that can be used to precisely measure the levels of risk of a portfolio?
What conditions are necessary for a risk-free asset to be free of risk? Provide an example. Is it really risk-free?
Show that the market portfolio must be on the capital market line and on the portion of the curve called the efficient frontier (see Section 21.2).
Why does this chapter provide an explanation of the development of mutual funds?
Can the risk of a portfolio be greater than the individual risk of each of the securities it contains? Under what circumstances?
Under which circumstances can the risk of a portfolio be less than the individual risk of each of the securities it contains?
The greater the number of shares in a portfolio, the less the marginal contribution to diversification of an additional security will be. True or false?
Will very wide diversification eliminate specific risk? And market risk?
Explain in a few lines why diversifiable risk cannot be remunerated on markets in equilibrium?
Given that diversifiable risk is not remunerated, would it be worthwhile to diversify an investment?
What is the rate of return required by the shareholder equal to?
What is the drawback of the β coefficient?
A shareholder requires a rate of return that is twice as high on a share with a β coefficient that is twice as high as that of another share. True or false?
What does a low-risk premium indicate?
On the graph on page 427, does the Alcatel-Lucent share seem under- or overvalued to you? What about the Daimler share? 14- 12- 10- Expected return (%) Steria EADS Peugeot Air France Rhodia
What is the strong point of the APT compared with the CAPM? And the weak point?
Will liquidity premiums tend to rise or fall during a crash? Why?
What does a negative liquidity premium indicate?
The standard deviation of the earnings on Bouygues shares is 40%, while for Siemens it is only 28%. However, Bouygues has a β of 1.13 and Siemens of 1.7. Explain how this is possible.
Explain why an investor would be prepared to require a lower return on a risk-free share for a share with a negative β.
How do you explain the fact that rates of return required by investors may be identical for two groups of totally different activities (oil and IT services for example) as long as they have the same
An experiment was recently carried out where a child, an astrologer and a financial analyst were each given €10,000 to invest for eight years. Who do you think achieved the best results?
When is the cost of capital equal to the cost of equity? Can the cost of capital be equal to the cost of debt?
Why does the cost of capital constitute a direct link between return on capital expenditure and the returns required by capital investors?
Why is the cost of capital not an accounting concept?
What is the cost of capital equal to?
Is the cost of equity equal to the return on the shares?
What is the cost of reserves equal to? And the cost of depreciation?
How many costs of capital are there in a company that has diversified into different(business) sectors but not geographic areas? What about if it has done so within each of the company’s divisions?
Can a company that invests in projects on which the returns are lower than its cost of capital continue to obtain resources through cash flow? Through debt? Through capital increases?
A listed company launches a takeover bid on another company at a price that is far too high. According to the cost of capital theory, what should the sanction be?
What is the difference between the zero coupon curve and the yield curve?
Why is a yield curve showing higher long-term interest rates than short-term rates(rising curve) called a normal curve?
What risk are we talking about when we say that government bonds are risk-free?
What is the “reinvestment risk”?
You observe the following prices for different bonds (note that the coupons on all of them have just been paid)(a) Calculate the return on each of these bonds.(b) Reconstruct the zero coupon curve at
In 2009 you notice that the yields to maturity of the same company’s two bonds, 5% of 2013 and 9% of 2013, are selling at 87.44 and 100.71, respectively, and the resulting yield to maturity is
Why is the bond rating important?
What is the default risk?
What is the “character” of a bond issuer?
What should a credit analyst consider as the basic of credit risk?
Should the analysis of covenants in high-yield corporate issues be carried out separately from other characteristics?
In an article in a popular daily publication, a statement similar to the following was made: “Repurchase agreements are extremely risky vehicles”. Explain why this statement is ambiguous.
Is project financing based on the personal and real guarantees of the sponsors?
What services can be offered as part of factoring?
In a securitisation transaction, is a company that transfers assets to an SPV at risk if these assets do not cover the debts of the SPV?
Why is adjustment necessary?
Define growth stock and yield stock.
What are the growth prospects for a company that pays out all of its profits?
Does a “high” P/E necessarily mean that the company is experiencing high growth?
What assumptions must be made for inverse P/E to provide an approximate estimate of required rate of return?
Will a change in required rate of return have a greater impact on a company that pays out 75% of its profits than a company that has a payout ratio of 5%, but which should increase to 75% in 25 years?
Will a share with a higher than average required rate of return for the same risk, be undervalued or overvalued?
What is dividend growth that is higher per share than for the total amount of dividends paid out a sign of? What is dividend growth that is higher for the total amount of dividends paid out than the
Is a company’s earnings growth the most important criteria defining a growth stock?
What does a PBR that is much higher than 1 mean?
Define a call or put option.
What are the six criteria for determining the value of an option?
What does the delta of an option indicate?
What impact will a rise in volatility have on the value of a call option? And a drop in interest rates? And payment of a dividend? And the extension of the maturity of an option? And an upward
Can you set the sale of a call option off against the purchase of a put option on the same underlying asset at the same maturity?
How would this investor find counterparties?
Show how, in the end, the investor always pays too much for the option. Why is this statement absurd?
Of the following four transactions, which carries the most risk:◦ purchase of a call option;◦ sale of a call option;◦ purchase of a put option;◦ sale of a put option;Why?
Time value is the anticipation of intrinsic value being stronger than it is now. However, intrinsic value can drop. Why then can time value not be negative?
In concrete terms, what does the difficulty in valuing an option boil down to?
Why are options particularly well suited to arbitrage strategies? And speculation?
Show how the purchase of an option and the sale of another option can protect you against the risk of a drop in the value of the underlying share, without costing you anything if you give up the
If you hold stock options on the shares in your company, would you be pleased to see the company paying out large dividends? Why?
In your view, what is the main contribution of the Black–Scholes model?
The Schauspielhaus in Berlin sells tickets thirty minutes before the start of every concert that has been sold out, known as Nacheinlasskarten.Holders of these tickets are entitled to occupy any free
You wish to value a call option on the Faurecia share (which does not pay dividends) after 6 months with a strike price of €35 and a 6-month duration. You do not know what volatility to factor in.
Redo the exercise above, assuming in the first case that the Faurecia share rises to €40 or falls to €25. What is the impact on the value of the option? What basic feature of the option have you
Can any financial product normally make it possible to obtain resources at below market cost?
Define: convertible bond, bond with equity warrants, preference share, investment certificate and bond redeemable in shares.
The bond market yield is 7%. A company issues a bond with equity warrants at a gross yield to maturity of 3% assuming the warrants are not exercised. What is the cost of this product? What is the
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