Exam 5: Understanding Risk

Calculate the expected value of an investment that has the following payoff frequency: a quarter of the time it will pay $2,000, half of the time it will pay $1,000, and the remaining time it will pay $0.

The difference between standard deviation and value at risk is:

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?

An automobile insurance company that writes millions of policies is practicing a form of:

If there are 1,000 people, each of whom owns a $100,000 house, and they each stand a 1/1,000 chance each year of suffering a fire that will totally destroy their house, what is the minimum that they would have to pay annually for fire insurance? E.L.= 0.001 ($100,000) + 0.999($0) = $100.00.Since the expected loss for each individual is $100 per year, the minimum that each would have to pay is $100.00 a year, in fact, given the probability of 1 in a 1000 homeowners in this group suffering a fire each year, at $100 each, on average, there should be just enough to compensate the person suffering the fire.

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 $2000?

You buy an asset for $2500.The asset will return $3300 half of the time and $2700, 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?

You study horse racing avidly and discover for this year's Kentucky Derby you think you have the field pretty well figured out.In fact, you calculate the expected return and it is the same as the expected return you are getting from the stock market.Is this investment in the race valuable to you?

Unique risk is another name for:

A risk-averse investor will:

What would be the impact of leverage on the expected return and standard deviation of purchasing an asset with 10% of the owner's funds and 90% borrowed funds?

An investment pays $1,500 half of the time and $500 half of the time.Its expected value and variance respectively are:

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

What would be the standard deviation for a $1000 risk-free asset that returns $1,100?

An investor who diversifies by purchasing a 50-50 mix of two stocks that are not perfectly positively correlated will find that the standard deviation of the portfolio is:

Uncertainties that are not quantifiable:

Unexpected inflation can benefit some people/firms and harm others.This is an example of:

Consider the following two investments.One is a risk-free investment with a $100 return.The other investment pays $2000 20% of the time and a $375 loss the rest of the time.Based on this information, answer the following: (i) Compute the expected returns and standard deviations on these two investments individually. (ii) Compute the value at risk for each investment. (iii) Which investment will risk-averse investors prefer, if either? Which investment will risk-neutral investors prefer, if either?

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

Systematic risk: