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Unit 4: Risk & Return and Leverage - Practice Quiz

FIN212 — Basic Financial Management 50 Questions
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1 Which of the following best defines return in a financial context?

A. The uncertainty associated with an investment
B. The gain or loss of a security in a particular period
C. The fixed interest rate provided by a bank
D. The total loss incurred from an investment

2 What is the formula for calculating the Holding Period Return (HPR) on a stock?

A.
B.
C.
D.

3 If you bought a share for $100, sold it for $110, and received a dividend of $5, what is your percentage return?

A. 12%
B. 15%
C. 10%
D. 5%

4 Which statistical measure is most commonly used to quantify the total risk of a single asset?

A. Correlation Coefficient
B. Standard Deviation
C. Mode
D. Median

5 The Expected Return () of a single asset given various economic scenarios is calculated as:

A. The weighted average of possible returns, where weights are the probabilities of occurrence
B. The highest possible return minus the lowest possible return
C. The sum of all possible returns
D. The return with the highest probability only

6 An investment has a 50% chance of earning a 20% return and a 50% chance of earning a 10% return. What is the Expected Return?

A. 10%
B. 12.5%
C. 15%
D. 30%

7 Which coefficient measures the risk per unit of return, allowing for comparison between assets with different expected returns?

A. Correlation
B. Coefficient of Variation
C. Covariance
D. Beta

8 Risk that represents the portion of an asset's risk that can be eliminated through diversification is called:

A. Unsystematic Risk
B. Beta Risk
C. Market Risk
D. Systematic Risk

9 In financial management, Leverage generally refers to:

A. The use of equity to finance assets
B. The use of fixed-cost assets or funds to magnify returns to owners
C. Investing only in risk-free assets
D. Reducing the debt in the capital structure

10 Which type of leverage is associated with the relationship between Sales and EBIT (Earnings Before Interest and Taxes)?

A. Operating Leverage
B. Combined Leverage
C. Financial Leverage
D. Working Capital Leverage

11 What is the formula for Degree of Operating Leverage (DOL) at a specific level of sales?

A.
B.
C.
D.

12 If a firm has High Operating Leverage, it implies:

A. A small change in Sales will result in a small change in EBIT
B. A small change in Sales will result in a large change in EBIT
C. The firm has no fixed costs
D. The firm has very high variable costs compared to fixed costs

13 Calculate the Contribution if Sales are and Variable Costs are .

A.
B.
C.
D.

14 A company has Sales of , Variable Costs of , and Fixed Operating Costs of . What is the Degree of Operating Leverage (DOL)?

A. 1.5
B. 4.0
C. 2.0
D. 2.5

15 Financial Leverage arises due to the presence of:

A. Fixed operating costs
B. Fixed financial charges (Interest/Preference Dividend)
C. High inventory levels
D. Variable costs

16 The Degree of Financial Leverage (DFL) measures the sensitivity of:

A. EPS to EBIT
B. Market Price to Book Value
C. EBIT to Sales
D. Sales to Fixed Costs

17 What is the formula for Degree of Financial Leverage (DFL) assuming no preference capital?

A.
B.
C.
D.

18 If a company has EBIT of and Interest expenses of , what is the DFL?

A. 5.0
B. 1.25
C. 1.20
D. 0.8

19 Combined Leverage (DCL) is calculated as:

A.
B.
C.
D.

20 Combined Leverage measures the relationship between changes in Sales and changes in:

A. EBIT
B. EBT
C. EPS
D. Operating Costs

21 Which of the following formulas represents the Degree of Combined Leverage (DCL)?

A.
B.
C.
D.

22 If DOL is 2.5 and DFL is 2.0, what is the Degree of Combined Leverage?

A. 1.25
B. 5.0
C. 0.5
D. 4.5

23 What is the Variance () of returns if the returns are 5%, 10%, and 15% with equal probability (Mean = 10%)?

A. 50
B. 12.5
C. 16.67
D. 25

24 Operating leverage is a measure of:

A. Business Risk
B. Market Risk
C. Interest Rate Risk
D. Financial Risk

25 Financial leverage is a measure of:

A. Operational Risk
B. Systematic Risk
C. Business Risk
D. Financial Risk

26 If a company has no debt and no preference shares, its Financial Leverage will be:

A. 0
B. 1
C. Negative
D. Infinite

27 A firm with high fixed operating costs and low variable costs is said to be:

A. Low Leverage
B. Risk Averse
C. Capital Intensive
D. Labor Intensive

28 Which of the following is true regarding Trading on Equity?

A. It refers to using debt to increase the return to equity shareholders
B. It refers to trading shares on the stock exchange
C. It implies avoiding all debt
D. It refers to issuing more equity shares

29 In the calculation of DFL, how is Preference Dividend (PD) treated if corporate tax rate is ?

A. Ignored completely
B. Subtracted directly from EBIT
C. Adjusted as and subtracted from EBIT in the denominator
D. Added to Interest

30 If Sales increase by 10% and EPS increases by 40%, what is the Degree of Combined Leverage (DCL)?

A. 0.25
B. 4.0
C. 400
D. 3.0

31 If the Break-even point is high, the Operating Leverage is generally:

A. Zero
B. Unrelated
C. Low
D. High

32 The percentage change in EBIT divided by the percentage change in Sales is the definition of:

A. DCL
B. DOL
C. DFL
D. ROI

33 If a stock price is $50, the expected dividend is $2, and the expected growth rate is 5%, what is the expected return using the Gordon Growth Model ()?

A. 5%
B. 9%
C. 4%
D. 10%

34 Which of the following reduces the Degree of Operating Leverage?

A. Increasing Variable Costs per unit
B. Reducing Sales volume
C. Increasing Sales price per unit
D. Increasing Fixed Costs

35 What indicates a favorable financial leverage?

A. ROI > Cost of Debt
B. EBIT is negative
C. ROI = Cost of Debt
D. ROI < Cost of Debt

36 In a probability distribution of returns, a "tight" distribution (peaked curve) implies:

A. High Risk
B. High Variance
C. No Return
D. Low Risk

37 Given: Contribution = , Fixed Costs = , Interest = . Calculate DFL.

A. 2.5
B. 5.0
C. 1.67
D. 1.5

38 If a firm has a DOL of 3 and Sales increase by 5%, EBIT will increase by:

A. 15%
B. 5%
C. 8%
D. 3%

39 Systematic risk is measured by:

A. Variance
B. Beta ()
C. Range
D. Standard Deviation

40 If an asset's return moves in the exact opposite direction to the market return, the correlation coefficient is:

A. -1
B. 0.5
C. +1
D. 0

41 Company A has high operating leverage and Company B has low operating leverage. In an economic downturn (falling sales), which company will suffer a sharper decline in EBIT?

A. Both will be equal
B. Neither will suffer
C. Company A
D. Company B

42 The Indifference Point in financial management refers to the level of EBIT where:

A. The firm goes bankrupt
B. Sales equal Variable Costs
C. EPS of two different financing plans are equal
D. Total Revenue equals Total Costs

43 Calculation: Sales = , VC = , FC = , Interest = . Calculate DCL.

A. 2.5
B. 2.0
C. 4.0
D. 8.0

44 Why is debt interest considered a "tax shield"?

A. It is not taxable
B. It increases the tax rate
C. It is paid after tax
D. It is tax-deductible, reducing taxable income

45 Real Return differs from Nominal Return because Real Return adjusts for:

A. Dividends
B. Inflation
C. Risk
D. Taxes

46 If Probability and . What is the variance?

A. 24
B. 16
C. 20
D. 4.9

47 Which leverage explains the relationship between % change in EBT and % change in EBIT?

A. Total Leverage
B. Operating Leverage
C. Financial Leverage
D. Combined Leverage

48 A firm has a negative DFL. This implies:

A. The firm has no debt
B. Sales are zero
C. EBIT is less than the Interest expense
D. Tax rate is negative

49 Which of the following is NOT required to calculate Operating Leverage?

A. Fixed Operating Costs
B. Variable Costs
C. Sales Revenue
D. Interest Expense

50 Total Risk of a firm is composed of:

A. Internal Risk + External Risk
B. Operating Risk + Sales Risk
C. Market Risk + Interest Risk
D. Business Risk + Financial Risk
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