1.Returns on shares of Lattice are predicted as follows: Lattice earns 0.10 retu

ID: 2765287 • Letter: 1

Question

1.Returns on shares of Lattice are predicted as follows: Lattice earns 0.10 return in recession and 0.20 return in a boom. An economist attributes a 0.40 chance of a recession and a 0.60 chance of a boom. Which of the following is closest to lattice’s variance?

0.0056

0.0024

0.0034

0.0083

2.Which of the following effects will have the result of increasing the amount of financial leverage in the firm? In each case, assume that all other activity in the firm does not change.

A shift of $100 from long-term debt to short-term debt.

An increase in the firm’s retained earnings account.

A new equity issue.

A new debt issue.

PLEASE ANSWER ALL QUESTIONS.

0.0056

0.0024

0.0034

0.0083

Explanation / Answer

Solution :

1..

state of economy

Probability (p)

return (r)

P xr (i.e mean)

(c-0.14)^2

b x e

Recession

0.4

0.1

0.04

0.0036

0.00144

boom

0.6

0.2

0.12

0.0016

0.00096

0.1600

0.0052

0.0024

Variance = p [(r - mean)^2]

^expected rate of return(mean) = 16%

Hence Variance = p [(r - mean)^2] = 0.0024.

2.. financial leverage arises when firm finance their majority assets by taking debt. Hence, option ‘D’ i.e A new debt issue will have the result of increasing the amount of financial leverage in the firm.