CCA Corporate Finance & Capital Structure Flashcards

What is the difference between systematic risk and unsystematic risk?

Answer: Systematic risk affects the entire market and cannot be diversified away; unsystematic risk is firm-specific and can be diversified

Systematic (market) risk affects all securities and cannot be diversified away, while unsystematic (firm-specific) risk can be reduced by holding a diversified portfolio.

Which metric measures the sensitivity of a stock's returns to movements in the overall market?

Answer: Beta

Beta measures how much a stock's returns move relative to the market; a beta of 1 means the stock moves in line with the market.

A company repurchases its own shares. What is the most likely immediate effect on earnings per share (EPS)?

Answer: EPS increases because the same earnings are spread over fewer shares

Share repurchases reduce the number of shares outstanding, so the same net income is divided over fewer shares, increasing EPS.

What is the primary purpose of a rights offering?

Answer: To allow existing shareholders to purchase additional shares at a discount before new investors

A rights offering gives existing shareholders the preemptive right to buy new shares at a discount, protecting them from dilution.

Which of the following best describes a leveraged buyout (LBO)?

Answer: A takeover financed mostly with debt, using the target's assets as collateral

In an LBO, a buyer (often private equity) acquires a company using substantial debt financing secured against the target's assets and cash flows.

The Capital Asset Pricing Model (CAPM) estimates the required return on a stock as:

Answer: Risk-free rate + Beta × (Market return – Risk-free rate)

CAPM states: Required return = Risk-free rate + Beta × Equity risk premium, where the equity risk premium is the market return minus the risk-free rate.