The IIT Madras BS Corporate Finance (Corporate Finance) Quiz 2 paper sat on 16 Mar 2025, in the January 2025 term: 25 questions for 100 marks in 120 minutes. Every question is below with its answer. Take it as a timed mock test to be marked, or read it through first.
Which of the following statements is incorrect?
Debt creditors are paid off first, and then, the equity owners are paid off.
Debt creditor bears less risk in comparison to equity owner.
Debt creditors share the profit earned by the concerned project.
Debt financing does not provide ownership rights.
Correct answer
Debt creditors share the profit earned by the concerned project.
At the optimal consumption point
The slope of the budget line is more than the marginal rate of substitution.
The consumer does not consume his whole income.
The budget line is tangent to the indifference curve.
The marginal utility of the goods is the same.
Correct answer
The budget line is tangent to the indifference curve.
What is the potential risk of short selling?
Limited loss potential
Unlimited profit potential
Unlimited loss potential
No financial risk
Correct answer
Unlimited loss potential
Which of the following statements is correct?
The feasible set is a subset of the minimum variance set.
The global minimum variance portfolio is the optimal portfolio for the investor.
The efficient frontier is a subset of the minimum variance set.
Investors with varying degree of risk-aversion haver different optimal risky portfolio.
Correct answer
The efficient frontier is a subset of the minimum variance set.
If the utility function of an individual is a linear function over wealth, what can we say about the individual’s risk attitude?
The individual is risk neutral
The individual is risk averse
The individual is risk lover
None of the other options
Correct answer
The individual is risk neutral
A borrower is called insolvent if
His capital exceeds his assets.
His liabilities exceed his assets.
His assets exceed his liabilities.
His liabilities exceed his capital.
Correct answer
His liabilities exceed his assets.
Sarah has mean-variance preferences represented by the utility function , where is the expected rate of return and is the standard deviation of the rate of return. He is considering two assets A and B: asset A has a 12% rate of return with 0.40 probability and a 18% rate of return with 0.60 probability, whereas asset B has a 28% rate of return with 0.50 probability and an 8% rate of return with 0.50 probability. Suppose Sarah has to choose between investing in asset A only or asset B only. Which asset would Sarah prefer?
Asset A
Asset B
Sarah is indifferent between the two assets
Information is not sufficient.
Correct answer
Asset A
What would be the fair price of a bet that pays 100 with a 20% probability, pays 80 with a 40% probability and pays 60 with a 40% probability?
84
48
52
76
Correct answer
76
Suppose a 1-year government bond is offering an 8% rate of return. Sumit has Rs 20,000, which he can invest in government bonds or lend to his friend Ramesh. He believes that Ramesh will pay back the promised amount with a 75% probability and will pay back nothing with a 25% probability. Assume that Sumit is risk neutral. What is the default premium that Sumit should ask from Ramesh?
37%
36%
17%
10%
Correct answer
36%
Axis Bank has assets of 1500 units, liabilities of 750 units and capital of 750 units. What is the leverage ratio for Axis Bank?
4
3
2
0.5
Correct answer
2
There are two assets: a risk-free asset that offers a 6% rate of return and a risky asset that has an expected rate of return of 24% and a standard deviation of 9%. What is the slope of the budget line of a portfolio consisting of these two assets (Note: standard deviation of portfolio return is on horizontal axis and expected return of portfolio is on vertical axis)?
2.5
-2.5
2
-2
Correct answer
2
Asset A has a correlation of 0.4 with the market and a standard deviation of 16%. If the market return has a standard deviation of 4%, what is the beta of asset A?
1.6
-0.6
0.75
2.5
Correct answer
1.6
You create a portfolio of 9 identical assets that have an expected return of 22% and a standard deviation of 12%. These 9 assets are uncorrelated with each other. What is the standard deviation of your portfolio?
32%
12%
8%
4%
Correct answer
4%
A grocery store can be worth 100 thousand in two years with a 35% probability or 200 thousand in two years with a 65% probability, depending on local consumer demand. The appropriate cost of capital is 12% per year. What is the present value of the outlet? (up to two decimal points)
147.32 thousand
131.54 thousand
119.98 thousand
110.50 thousand
Correct answer
131.54 thousand
7%
19%
15%
23%
Correct answer
23%
Suppose Rakesh decides to short sell 50 shares of Wipro Inc. The current share price for Wipro Inc is Rs 200. At the end of 1 year, share price for Wipro Inc drops to Rs 190. How much profit does Rakesh makes by exercising shorting on Wipro Inc shares?
Rs 190
Rs 200
Rs 500
Rs 1000
Correct answer
Rs 500
You purchase a farm located near a river for 500 thousand units. You believe that there is a 4% chance of flooding in the river in the next year. If there is a flood, the produce in the farm gets destroyed, and the total payoff is 240 thousand units in the next year; otherwise, the farm generates a payoff of 600 thousand units in the next year. The appropriate cost of capital is 20% per year. Suppose you finance your purchase with a loan of 400 thousand units and the remaining amount as equity.
Based on the above data, answer the given subquestions.
What would be the appropriate promised rate of return that the creditor of the loan would demand?
10.69%
22.50%
25.50%
31.43%
Correct answer
22.50%
You purchase a farm located near a river for 500 thousand units. You believe that there is a 4% chance of flooding in the river in the next year. If there is a flood, the produce in the farm gets destroyed, and the total payoff is 240 thousand units in the next year; otherwise, the farm generates a payoff of 600 thousand units in the next year. The appropriate cost of capital is 20% per year. Suppose you finance your purchase with a loan of 400 thousand units and the remaining amount as equity.
Based on the above data, answer the given subquestions.
What is the expected payoff for the equity owner in the next year?
105.6 thousand
250 thousand
100.75 thousand
40 thousand
Correct answer
105.6 thousand
Based on the above data, answer the given subquestions.
What is Nikita’s expected utility?
100
37.2
24.0
35.0
Correct answer
35.0
Based on the above data, answer the given subquestions.
If Nikita pays p for an insurance policy that would pay her 600 units if she suffered a severe injury, then she would be sure to have an income of 800-p regardless of whether she is injured. What would be the largest price that Nikita would be willing to pay for such insurance?
16.5 units
187.5 units
120.5 units
244.5 units
Correct answer
187.5 units
Based on the above data, answer the given subquestions.
A portfolio is formed with 60% of wealth invested in Asset 1 and 40% of wealth invested in Asset 2. What would be the expected rate of return of the portfolio?
0.14
0.16
0.17
0.18
Correct answer
0.17
Based on the above data, answer the given subquestions.
What would be the standard deviation of the rate of return of the portfolio?
0.15
0.20
0.24
0.29
Correct answer
0.24
Based on the above data, answer the given subquestions.
Suppose you would like to construct a portfolio with an expected rate of return of 19%. What weights would you put on Asset 1 and Asset 2, respectively?
40%, 60%
50%, 50%
30%, 70%
20%, 80%
Correct answer
20%, 80%
Based on the above data, answer the given subquestions.
What are the weights of Asset 1 and Asset 2 in the minimum variance portfolio?
77.78%, 22.22%
32.22%, 67.78%
68.96%, 31.04%
49.44%, 50.56%
Correct answer
68.96%, 31.04%
Based on the above data, answer the given subquestions.
What is the expected rate of return of the minimum variance portfolio?
13.22%
16.55%
17.46%
18.78%
Correct answer
16.55%
