MS MS in Finance 1 — Questions and Answers
Question 1: What does the Capital Asset Pricing Model (CAPM) primarily describe?
- The relationship between systematic risk and expected return of an asset (Correct answer)
- The optimal capital structure between debt and equity
- The pricing of options based on underlying volatility
- The calculation of a firm's weighted average cost of capital
Correct answer: The relationship between systematic risk and expected return of an asset
CAPM states that the expected return of an asset equals the risk-free rate plus beta times the market risk premium, establishing a linear relationship between systematic risk and expected return.
Question 2: What is the 'time value of money' principle?
- A dollar received today is worth more than a dollar received in the future (Correct answer)
- Interest rates always increase over time
- Future cash flows are more certain than present ones
- Inflation always erodes the value of saved money at a fixed rate
Correct answer: A dollar received today is worth more than a dollar received in the future
The time value of money holds that money available now is worth more than an identical sum in the future due to its earning potential through investment or interest.
Question 3: Which financial statement shows a company's revenues, expenses, and profits over a period?
- Income statement (Correct answer)
- Balance sheet
- Cash flow statement
- Statement of shareholders' equity
Correct answer: Income statement
The income statement (profit and loss statement) summarizes a company's revenues, costs, and expenses during a specific reporting period, culminating in net income or loss.
Question 4: What does 'beta' measure in portfolio theory?
- A stock's sensitivity to market-wide movements (systematic risk) (Correct answer)
- The total risk of a portfolio including diversifiable risk
- The ratio of a company's debt to equity
- The excess return per unit of total risk
Correct answer: A stock's sensitivity to market-wide movements (systematic risk)
Beta measures how much a security's returns move relative to the overall market; a beta of 1.5 means the stock tends to move 1.5 times as much as the market.
Question 5: What is a 'derivative' in financial markets?
- A financial contract whose value is derived from an underlying asset (Correct answer)
- A bond issued by a government entity
- A stock that pays consistent dividends
- A mutual fund tracking a market index
Correct answer: A financial contract whose value is derived from an underlying asset
A derivative is a financial instrument (such as options, futures, or swaps) whose value depends on the price of an underlying asset like stocks, commodities, or interest rates.
Question 6: Which concept describes the rate of return at which the net present value of a project's cash flows equals zero?
- Internal Rate of Return (IRR) (Correct answer)
- Payback period
- Profitability index
- Return on equity
Correct answer: Internal Rate of Return (IRR)
The Internal Rate of Return (IRR) is the discount rate that sets the NPV of all cash flows from a project to exactly zero, used to evaluate investment attractiveness.
MS MS in Finance 1
What does the Capital Asset Pricing Model (CAPM) primarily describe?