CGA CGA Corporate Finance & Capital Markets 2 — Questions and Answers
Question 1: What does the term 'systematic risk' refer to in portfolio theory?
- Risk that can be eliminated through diversification
- Risk inherent to the entire market that cannot be diversified away (Correct answer)
- Risk specific to one company
- Risk arising from poor management decisions
Correct answer: Risk inherent to the entire market that cannot be diversified away
Systematic risk (market risk) affects all securities and cannot be reduced through diversification, unlike unsystematic risk.
Question 2: A company's beta is 1.4. If the market return is 10% and the risk-free rate is 3%, what is the required return using CAPM?
- 12.8% (Correct answer)
- 10.0%
- 13.4%
- 17.0%
Correct answer: 12.8%
CAPM: Required return = 3% + 1.4 × (10% − 3%) = 3% + 9.8% = 12.8%.
Question 3: Which of the following is an example of an unsecured short-term debt instrument issued by corporations?
- Treasury bill
- Commercial paper (Correct answer)
- Mortgage bond
- Debenture
Correct answer: Commercial paper
Commercial paper is a short-term, unsecured promissory note issued by corporations to fund short-term liabilities.
Question 4: What is the primary purpose of a sinking fund provision in a bond indenture?
- To increase the coupon rate over time
- To allow the issuer to repurchase bonds gradually before maturity (Correct answer)
- To protect against inflation
- To convert bonds to equity
Correct answer: To allow the issuer to repurchase bonds gradually before maturity
A sinking fund requires the issuer to set aside funds periodically to retire portions of the bond issue before maturity, reducing default risk.
Question 5: Which valuation model values a stock based on the present value of expected future dividends growing at a constant rate?
- Price/Earnings model
- Gordon Growth Model (Correct answer)
- Discounted Cash Flow model
- Capital Asset Pricing Model
Correct answer: Gordon Growth Model
The Gordon Growth Model (dividend discount model) values stock as D1 ÷ (r − g), where dividends grow at a constant rate g.
Question 6: A rights offering allows existing shareholders to:
- Sell shares back to the company at par value
- Purchase new shares at a discount before the public (Correct answer)
- Convert bonds to equity at their discretion
- Receive dividends in additional shares
Correct answer: Purchase new shares at a discount before the public
In a rights offering, current shareholders receive the right to buy newly issued shares at a below-market price, maintaining their proportional ownership.
CGA CGA Corporate Finance & Capital Markets 2
What does the term 'systematic risk' refer to in portfolio theory?