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Indian Institute of Technology Kharagpur
Corporate Finance
Assignment- 1
TYPE OF QUESTION: MCQ
Number of questions: 20 Total mark: 20 X 1 = 20
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QUESTION 1:
Which of the following type of financing options allows a company to use its internally
generated profits without incurring any external obligations?
a. Equity financing
b. Long-term borrowing
c. Short-term borrowing
d. Retained earnings
Correct Answer: d
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QUESTION 2:
When calculating the expected return of a portfolio, the probabilities of expected returns of
individual assets are important because they:
a. Determine the risk-free rate of return
b. Reflect the historical performance of each individual asset
c. Represent the likelihood of different scenarios occurring for each individual asset
d. Indicate the market value of each individual asset
Correct Answer: c
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Indian Institute of Technology Kharagpur
QUESTION 3:
How many covariance terms does a portfolio of 7 Stocks have?
a. 16
b. 49
c. 42
d. 24
Correct Answer: c
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QUESTION 4:
A security with a beta of 1.5 implies that:
a. The security’s returns are 50% higher than the market returns
b. The security’s returns are 1.5 times more volatile than the market returns
c. The security’s returns are 50% lower than the market returns
d. The security has a positive covariance of 1.5 with the market
Correct Answer: b
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QUESTION 5:
Shyam bought of XYZ Ltd. on January 1, 2022, at Rs 250. He sold the stock on December 31,
2022, at Rs. 280 after receiving a dividend of Rs. 20 on the same day. What was the return he
realised from holding the stock for the given period of time?
a. 12%
b. 16%
c. 20%
d. 24%
Correct Answer: c
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Indian Institute of Technology Kharagpur
QUESTION 6:
Which of the following is a well-accepted definition of realized return?
a. It includes capital gains only
b. It includes interim income only
c. It includes both interim incomes if any, and capital gains
d. It includes dividend payments over the period
Correct Answer: c
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QUESTION 7:
Which of the following statements is true about preferred equity?
a. It has a higher risk profile compared to common equity
b. It has a lower risk profile compared to common equity
c. It has a fixed maturity date like bonds
d. It is entitled to dividend payment after the common equity
Correct Answer: b
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QUESTION 8:
The beta coefficient of CAPM measures:
a. Total risk of an investment
b. The risk-free return of an investment
c. The total return of an investment
d. The sensitivity of an investment’s return to market movements
Correct Answer: d
______________________________________________________________________________
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Indian Institute of Technology Kharagpur
QUESTION 9:
Suppose the average return of Nifty Index for last 5 years are as follows
Year Return(R)
2016 13.9%
2017 -7.6%
2018 17.8%
2019 22%
2020 15.6%
Calculate the Average annual return (in percentage) that an investor could expect for any given
year.
a. 17.65 %
b. 16.74 %
c. 12.34 %
d. -15.86 %
Correct Answer: c
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QUESTION 10:
The return of last 6 years of listed security are as follows
2015 2016 2017 2018 2019 2020
14.2% 15.5% 16.7% 11.4% 9% 11%
6 years ago, the price of the security was 130 per share.
Calculate the return for the holding period.
a. 123.84%
b. 107.47%
c. 113.24%
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d. 125.47%
Correct Answer: b
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QUESTION 11:
The Capital Asset Pricing Model (CAPM) uses risk-free rates and market risk premiums to
calculate
a. Expected return
b. Standard deviation
c. Beta
d. Sharpe Ratio
Correct Answer: a
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QUESTION 12:
If the required return of a stock is lower than the expected return, it indicates that –
a. The stock is overvalued
b. The stock is undervalued
c. The stock is fairly valued
d. The required rate of return has no relationship to the expected return
Correct Answer: b
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QUESTION 13:
The Security Market Line (SML) represents the relationship between
a. Risk and return trade-off
b. Total risk of marketable securities
c. Systematic risk of marketable securities
d. Unsystematic risk of marketable securities
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Indian Institute of Technology Kharagpur
Correct Answer: a
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QUESTION 14:
Calculate the annual return realized by Jiggle who bought a stock of Violence Ltd on Dec 1,
2019 and sold the stock on Nov 30, 2020. The company paid the following dividends.
Date Dec 1, Dec 31, Mar 31, Jun 30, Sep 30, Nov 30,
2019 2019 2020 2020 2020 2020
Price 290.90 283.90 269.40 264.90 281.30 267.30
Dividend __ 40.80 0.90 0.90 0.90 __
a. 6.14 %
b. 7.25 %
c. 8.05 %
d. 9.75 %
Correct Answer: a
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QUESTION 15:
Which of the following is the primary objective of portfolio diversification?
a. Minimum guaranteed returns
b. Minimizing risk
c. Achieving a specific asset allocation
d. Generating income
Correct Answer: b
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QUESTION 16:
Assessing the risk profile of a business involves analyzing its:
a. Dividend pay-out ratio
b. Operating cash flow
c. Debt-to-equity ratio
d. Profit and loss statement
Correct Answer: c
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QUESTION 17:
WIFA Plant Ltd. stock has a beta of 0.80, while PFA Ltd. stock has a beta of 1.20. The risk-free
rate and the expected return on the market are 6% and 9% respectively. According to CAPM the
required return on stock of WIFA & PFA should be _____ & ______ respectively.
a. 8.2 %, 12.8 %
b. 9.6 %, 12.8%
c. 8.4 %, 9.6%
d. 7.2 %, 11.8 %
Correct Answer: c
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QUESTION 18:
The principal-agent problem arises due to:
a. The lack of communication between managers and employees
b. The separation of ownership and control in a firm
c. Conflicts of interest between shareholders and customers
d. Inefficient market conditions
Correct Answer: b
_____________________________________________________________________________
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Indian Institute of Technology Kharagpur
QUESTION 19:
A portfolio contains three stocks(S). The weight of S1(w1) is 0.6, while the weight of S2(w2) is
0.3. Calculate the weight of S3(w3).
a. 0.7
b. 0.3
c. 0.1
d. 0.4
Correct Answer: c
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QUESTION 20:
Which financial instrument is typically a long-term debt instrument issued by both corporations
and governments?
a. Preference shares
b. Equity shares
c. Debenture
d. Bonds
Correct Answer: d
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Indian Institute of Technology Kharagpur
Explanation to the questions
Question 1. Retained Earnings (Details in Slide)
Question 2. When calculating the expected return of a portfolio, the probabilities of expected
returns of individual assets are important because they reflect the likelihood of different
scenarios occurring for each individual asset. These probabilities help weigh the potential returns
of each asset based on the likelihood of those returns being realized. By considering the
probabilities, the expected return of the overall portfolio can be estimated, considering the
potential outcomes of the individual assets.
Question 3. Number of Covariance terms in a portfolio = (N2-N)
Where N = No. of Stocks in a portfolio.
As per the question N = 7
No. of Covariance terms = (N2-N)
= (72-7) = 42
Question 4. A beta of 1.5 means the security is expected to have 1.5 times the overall market’s
volatility (or risk). If the market experiences a 1% change, the security with a beta of 1.5 would
be expected to have a 1.5% change in its return.
Question 5. Rt+1 = +
= 20/250 + (280-250)/250
= 0.20 or 20%
Question 6. It includes both interim income, if any, and capital gains.
Question 7. Preferred equity is generally considered to have a lower risk profile compared to
common equity due to its priority in dividend payment and potential for fixed income. However,
it still carries more risk than debt security and does not have fixed maturity date.
Question 8. Refer to slides
Question 9. =
= 1/5 (0.139-0.076+0.178+0.22+0.156)
= 12.34%
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Question 10. 120 × 1.142 × 1.155 × 1.167 × 1.114 × 1.09 × 1.11 = 248.96
Return = (248.96-120)/120 × 100 = 107.47%
Question 11. Expected Return (Details in Slide)
Question 12. The security is undervalued. (Details in slides)
Question 13. Refer to slides
Question 14. First, we compute realized return between each dividend interval using the formula
+ ;
Date Dec 1, Dec 31, Mar 31, Jun 30, Sep 30, Nov 30,
2019 2019 2020 2020 2020 2020
Price 290.90 283.90 269.40 264.90 281.30 267.30
Dividend __ 40.80 0.90 0.90 0.90 __
Return __ 11.62% -4.79% -1.34% 6.53% -4.98%
Then, we find one year return by compounding them
1 + Rannual = (1+R1) (1+R2) (1+R3) (1+R4) (1+R5)
= 1.0614
Rannual = 0.0614 or 6.14%
Question 15. Minimizing risk
Question 16. The debt-to-equity structure tells us about the risk exposure of the firm.
Question 17. As per CAPM E(ri) = rf + βi[E(rM) - rf]
WIFA plant Ltd. PFA ltd.
= 0.06 + 0.80[0.09 - 0.06] = 0.06 + 1.20[0.09 – 0.06]
= 0.084 or 8.4% = 0.096 or 9.6%
Question 18. The principal-agent problem arises from the company's separation of ownership
and control. The principal refers to the owners (shareholders) who delegate decision-making
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authority to agents, such as managers or executives, to run the company on their behalf. The
principal-agent problem arises because agents may have different interests and incentives than
the owners, leading to potential conflicts of interest.
Question 19. The sum of all the weights in a portfolio is supposed to be 1.
So here we have, S1(w1) = 0.6
S2(w2) = 0.3
S3(w3) = 1- [S1(w1) + S2(w2)]
= 1- [0.6 + 0.3] = 0.1
Question 20. Refer to slides.
