Question 1

If the probability of an outcome is zero, you know the outcome is:

Accepted Answer

A)  more likely to occur. 
B)  certain to occur. 
C)  less likely to occur. 
D)  certain not to occur.

Question 2

Risk-free investments have rates of return:

Accepted Answer

A)  equal to zero. 
B)  with a standard deviation equal to zero. 
C)  that are uncertain, but have a certain time horizon. 
D)  that exhibit a large spread of potential payoffs.

Question 3

Why isn't it correct to say that people who are risk averse avoid risk?

Accepted Answer

The answer of Why isn't it correct to say that...

Question 4

Another name for the expected value of an investment would be the:

Accepted Answer

A)  mean value. 
B)  upper-end value. 
C)  certain value. 
D)  risk-free value.

Question 5

The variance of a portfolio of assets:

Accepted Answer

A)  decreases as the number of assets increases. 
B)  increases as the number of assets increase. 
C)  approaches 0 as the number of assets decreases. 
D)  approaches 1 as the number of assets increases.

Question 6

You do some research and find for a driver of your age and gender the probability of having an accident that results in damage to your automobile exceeding $100 is 1/10 per year. Your auto insurance company will reduce your annual premium by $40 if you will increase your collision deductible from $100 to $250. Should you? Explain.

Accepted Answer

The answer of You do some research and find for...

Question 7

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

Accepted Answer

A)  mutual fund. 
B)  hedging risk. 
C)  spreading risk. 
D)  eliminating systematic risk.

Question 8

The difference between standard deviation and value at risk is:

Accepted Answer

A)  nothing, they are two names for the same thing. 
B)  value at risk is a more common measure in financial circles than is standard deviation. 
C)  standard deviation reflects the spread of possible outcomes where value at risk focuses on the value of the worst outcome. 
D)  value at risk is expected value times the standard deviation.

Question 9

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?

Accepted Answer

The answer of If there are 1,000 people, each of...

Question 10

When measuring the risk of an asset:

Accepted Answer

A)  one must measure the uncertainty about the size of future payoffs. 
B)  it is necessary to incorporate uncertainties that are not quantifiable. 
C)  one must remember that the concept of risk applies only to financial markets, not to financial intermediaries. 
D)  one cannot use other investments to evaluate the asset's risk.

Question 11

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.

Accepted Answer

The answer of Calculate the expected value of an investment...

Question 12

Which of the following statements is true?

Accepted Answer

A)  Leverage increases expected return and increases risk. 
B)  Leverage increases expected return and reduces risk. 
C)  Leverage decreases expected return but has no effect on risk. 
D)  Leverage decreases expected return and increases risk.

Question 13

Investment A pays $1,200 half of the time and $800 half of the time. Investment B pays $1,400 half of the time and $600 half of the time. Which of the following statements is correct?

Accepted Answer

A)  Investment A and B have the same expected value, but A has greater risk. 
B)  Investment B has a higher expected value than A, but also greater risk. 
C)  Investment A and B have the same expected value, but A has lower risk than B. 
D)  Investment A has a greater expected value than B, but B has less risk.

Question 14

An investment will pay $2,000 half of the time and $1,400 half of the time. The standard deviation for this investment is:

Accepted Answer

A)  $90,000. 
B)  $300. 
C)  $1,700. 
D)  $30.

Question 15

Spreading risk involves:

Accepted Answer

A)  finding assets whose returns are perfectly negatively correlated. 
B)  adding assets to a portfolio that move independently. 
C)  investing in bonds and avoiding stocks during bad times. 
D)  building a portfolio of assets whose returns move together.

Question 16

The standard deviation is generally more useful than the variance because:

Accepted Answer

A)  it is easier to calculate. 
B)  variance is a measure of risk, where standard deviation is a measure of return. 
C)  standard deviation is calculated in the same units as payoffs and variance isn't. 
D)  it can measure unquantifiable risk.

Question 17

If a fair coin is tossed, the probability of coming up with either a head or a tail is:

Accepted Answer

A)  ½ or 50 percent. 
B)  Zero. 
C)  1 or 100 percent. 
D)  Unquantifiable.

Question 18

Hedging risk and spreading risk are two ways to:

Accepted Answer

A)  increase expected returns from a portfolio. 
B)  diversify a portfolio. 
C)  lower transaction costs. 
D)  match up perfectly positively correlated assets.

Question 19

The expected value of an investment:

Accepted Answer

A)  is what the owner will receive when the investment is sold. 
B)  is the sum of the payoffs. 
C)  is the probability-weighted sum of the possible outcomes. 
D)  cannot be determined in advance.

Question 20

Comparing a lottery where a $1 ticket purchases a chance to win $1 million with another lottery in which a $5,000 ticket purchases a chance to win $5 billion, we notice many people would participate in the first but not the second, even though the odds of winning both lotteries are the same. We can perhaps best explain this outcome by:

Accepted Answer

A)  higher expected value for the lottery paying $1 million. 
B)  higher expected value for the lottery paying $5 billion. 
C)  lower value at risk for the lottery paying $1 million. 
D)  higher value at risk for the lottery paying $1 million.

Exam 5: Understanding Risk