Question 1

Which of the following statements is most correct?

Accepted Answer

A)  Usually higher expected returns are associated with higher risk premiums. 
B)  Usually higher risk premiums are associated with lower expected returns. 
C)  Usually lower expected returns are associated with higher risk premiums. 
D)  Usually expected returns are not associated with risk premiums. 
A)  Usually higher expected returns are associated with higher risk premiums. 
B)  Usually higher risk premiums are associated with lower expected returns. 
C)  Usually lower expected returns are associated with higher risk premiums. 
D)  Usually expected returns are not associated with risk premiums.

Question 2

Which of the following would not be included in a definition of risk?

Accepted Answer

A)  Risk is a measure of uncertainty. 
B)  Risk can always be avoided at no cost. 
C)  Risk has a time horizon. 
D)  Risk usually involves some future payoff. 
A)  Risk is a measure of uncertainty. 
B)  Risk can always be avoided at no cost. 
C)  Risk has a time horizon. 
D)  Risk usually involves some future payoff.

Question 3

An individual who is risk-averse:

Accepted Answer

A)  never takes risks. 
B)  accepts risk but only when the expected return is very small. 
C)  requires larger compensation when the risk increases. 
D)  will accept a lower return as risk rises. 
A)  never takes risks. 
B)  accepts risk but only when the expected return is very small. 
C)  requires larger compensation when the risk increases. 
D)  will accept a lower return as risk rises.

Question 4

Consider an individual who plans to buy a new home. He has two options: (i) pay for mortgage insurance (that insures the lender in case the borrower defaults), or (ii) pay the lender a higher interest rate for the mortgage. Describe how these two options are related to the concept
of risk premium and the lender's aversion to risk. Why does the interest rate on the mortgage differ in these two options?

Accepted Answer

In option (ii), the risk premium on the

Question 5

When considering different investments, a risk-averse investor is most likely to focus on purchasing:

Accepted Answer

A)  investments with the greatest spread in the expected rate of return. 
B)  investments that offer the lowest standard deviation in the investments' expected rates of return for any given expected rate of return. 
C)  only risk-free investments. 
D)  investments with the lowest risk premium, regardless of the expected rate of return. 
A)  investments with the greatest spread in the expected rate of return. 
B)  investments that offer the lowest standard deviation in the investments' expected rates of return for any given expected rate of return. 
C)  only risk-free investments. 
D)  investments with the lowest risk premium, regardless of the expected rate of return.

Question 6

In order to benefit from diversification, the returns on assets in a portfolio must:

Accepted Answer

A)  be perfectly positively correlated. 
B)  be perfectly negatively correlated. 
C)  positively correlated but not perfectly. 
D)  have the same idiosyncratic risks. 
A)  be perfectly positively correlated. 
B)  be perfectly negatively correlated. 
C)  positively correlated but not perfectly. 
D)  have the same idiosyncratic risks.

Question 7

Given a choice between two investments with the same expected payoff most people will:

Accepted Answer

A)  choose the one with the lower standard deviation. 
B)  opt for the one with the higher standard deviation. 
C)  be indifferent since the expected payoffs are the same. 
D)  calculate the variance to assess the relative risks of the two choices. 
A)  choose the one with the lower standard deviation. 
B)  opt for the one with the higher standard deviation. 
C)  be indifferent since the expected payoffs are the same. 
D)  calculate the variance to assess the relative risks of the two choices.

Question 8

Up to what amount would a risk-neutral gambler pay to enter a game where on the flip of a fair coin, if you call the correct outcome the payoff is $2,000?

Accepted Answer

A)  More than $1000 but less than $2000. 
B)  Up to $2,000. 
C)  Up to $1,000. 
D)  More than $1,500. 
A)  More than $1000 but less than $2000. 
B)  Up to $2,000. 
C)  Up to $1,000. 
D)  More than $1,500.

Question 9

Consider the following two assets with probability of return = Pi and return = Ri. Calculate the expected return for each and the standard deviation. Which one carries the greatest risk? Why?

Accepted Answer

For asset A, the expected return = 0.4(1

Question 10

If the returns of two assets are perfectly positively correlated, an investor who puts half of his/her savings into each will:

Accepted Answer

A)  reduce risk. 
B)  have a higher expected return. 
C)  not gain from diversification. 
D)  reduce risk but lower the expected return. 
A)  reduce risk. 
B)  have a higher expected return. 
C)  not gain from diversification. 
D)  reduce risk but lower the expected return.

Question 11

An investor practicing hedging would be most likely to:

Accepted Answer

A)  avoid the stock market and focus on bonds. 
B)  purchase shares in general motors and buy U.S. treasury bonds. 
C)  purchase shares in general motors and Amoco oil. 
D)  put his/her invested funds in CDs. 
A)  avoid the stock market and focus on bonds. 
B)  purchase shares in general motors and buy U.S. treasury bonds. 
C)  purchase shares in general motors and Amoco oil. 
D)  put his/her invested funds in CDs.

Question 12

A $500 investment has the following payoff frequency: half of the time it will pay $350 and the other half of the time it will pay $900. Its standard deviation and value at risk respectively are:

Accepted Answer

A)  $275; $150 
B)  $625; $275 
C)  $275; $350 
D)  $125; $500 
A)  $275; $150 
B)  $625; $275 
C)  $275; $350 
D)  $125; $500

Question 13

Professional gamblers know that the odds are always in favor of the house (casinos). The fact that they gamble says they are:

Accepted Answer

A)  irrational. 
B)  risk-neutral. 
C)  risk-averse. 
D)  risk seekers. 
A)  irrational. 
B)  risk-neutral. 
C)  risk-averse. 
D)  risk seekers.

Question 14

Explain why returns on assets compensate for systematic risk but not for idiosyncratic risk.

Accepted Answer

Idiosyncratic risk can be redu

Question 15

Systematic risk:

Accepted Answer

A)  is the risk eliminated through diversification. 
B)  represents the risk affecting a specific company. 
C)  cannot be eliminated through diversification. 
D)  is another name for risk unique to an individual asset. 
A)  is the risk eliminated through diversification. 
B)  represents the risk affecting a specific company. 
C)  cannot be eliminated through diversification. 
D)  is another name for risk unique to an individual asset.

Question 16

An investor puts $1,000 into an investment that will return $1,250 one-half of the time and $900 the remainder of the time. The expected return for this investor is:

Accepted Answer

A)  $1,075 
B)  5.0% 
C)  7.5% 
D)  15.0% 
A)  $1,075 
B)  5.0% 
C)  7.5% 
D)  15.0%

Question 17

An investment with a large spread between possible payoffs will generally have:

Accepted Answer

A)  a low expected return. 
B)  a high standard deviation. 
C)  a low value at risk. 
D)  both a low expected return and a low value at risk. 
A)  a low expected return. 
B)  a high standard deviation. 
C)  a low value at risk. 
D)  both a low expected return and a low value at risk.

Question 18

Apply the definition of risk provided in the textbook to an individual's decision to purchase a car insurance policy. Suppose that the individual has two possibilities: no accident ($0 gain/loss) and accident (-$30,000 loss). If the probability of an accident is lower than the probability of an accident occurring (say the probability of an accident is 10%), then why do people buy car insurance? How is this related to the concept of value at risk and the time horizon of investment decisions?

Accepted Answer

People buy car insurance in order to sha

Question 19

Which of the following statements is true?

Accepted Answer

A)  Leverage increases expected return while lowering risk. 
B)  Leverage increases risk. 
C)  Leverage lowers the expected return and lowers risk. 
D)  Leverage lowers the expected return and increases risk. 
A)  Leverage increases expected return while lowering risk. 
B)  Leverage increases risk. 
C)  Leverage lowers the expected return and lowers risk. 
D)  Leverage lowers the expected return and increases risk.

Question 20

You buy an asset for $2,500. The asset will return $3,300 half of the time and $2,700, the other half. The expected return is 20% (a gain of $500) and the standard deviation is 12% ($300). How would using $1,250 of borrowed funds change the expected return and standard deviation specifically?

Accepted Answer

Borrowing 50% of the funds needed to pur

Exam 5: Understanding Risk

Which of the following statements is most correct?

Which of the following would not be included in a definition of risk?

An individual who is risk-averse:

When considering different investments, a risk-averse investor is most likely to focus on purchasing:

In order to benefit from diversification, the returns on assets in a portfolio must:

Given a choice between two investments with the same expected payoff most people will:

Up to what amount would a risk-neutral gambler pay to enter a game where on the flip of a fair coin, if you call the correct outcome the payoff is $2,000?

Consider the following two assets with probability of return = Pi and return = Ri. Calculate the expected return for each and the standard deviation. Which one carries the greatest risk? Why?

If the returns of two assets are perfectly positively correlated, an investor who puts half of his/her savings into each will:

An investor practicing hedging would be most likely to:

A $500 investment has the following payoff frequency: half of the time it will pay $350 and the other half of the time it will pay $900. Its standard deviation and value at risk respectively are:

Professional gamblers know that the odds are always in favor of the house (casinos). The fact that they gamble says they are:

Explain why returns on assets compensate for systematic risk but not for idiosyncratic risk.

Systematic risk:

An investor puts $1,000 into an investment that will return $1,250 one-half of the time and $900 the remainder of the time. The expected return for this investor is:

An investment with a large spread between possible payoffs will generally have:

Which of the following statements is true?

You buy an asset for $2,500. The asset will return $3,300 half of the time and $2,700, the other half. The expected return is 20% (a gain of $500) and the standard deviation is 12% ($300). How would using $1,250 of borrowed funds change the expected return and standard deviation specifically?

An Introduction to Money and the Financial System

Money and the Payments System

Financial Instruments, Financial Markets, and Financial Institutions

Future Value, Present Value and Interest Rates

Bonds, Bond Prices, and the Determination of Interest Rates

The Risk and Term Structure of Interest Rates

Stocks, Stock Markets and Market Efficiency

Derivatives: Futures, Options, and Swaps

Foreign Exchange

The Economics of Financial Intermediation

Depository Institutions: Banks and Bank Management

Financial Industry Structure

Regulating the Financial System

Central Banks in the World Today

The Structure of Central Banks: The Federal Reserve and the European Central Bank

The Central Bank Balance Sheet and the Money Supply Process

Monetary Policy: Stabilizing the Domestic Economy

Exchange Rate Policy and the Central Bank

Money Growth, Money Demand and Modern Monetary Policy

Output, Inflation, and Monetary Policy

Understanding Business Cycle Fluctuations

Modern Monetary Policy and the Challenges Facing Central Bankers

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