Question 1

Suppose a person has a 1/100 chance of being mugged on the street.His utility function is √(Wealth).He initially has $1,600 which he carries on him at all times.If he's mugged he loses all of his money.What is the maximum he would be willing to pay to insure his money against mugging?

A)$40.13
B)$16
C)$25.67
D)$34.84

D

Accepted Answer

D

Question 2

Community rating and adverse selection are somewhat related concepts in insurance policy analysis.Which of the following are true regarding adverse selection:&#10;A)given equal insurance premiums across groups, the most costly households will tend to buy insurance, while the least costly households will not.&#10;B)adverse selection limits rate differences to selected categories, which does not allow insurance companies to charge each group according to its expected cost.&#10;C)only the sickest or most dangerous are likely to buy insurance.&#10;D)adverse selection refers to bad choices among some individuals.&#10;E)a and c are both correct.

Accepted Answer

Adverse selection occurs when there is asymmetric information between buyers and sellers, leading to situations where those most likely to need insurance (the most costly or riskiest individuals) are more inclined to purchase it (A and C). This can result in a disproportionate number of high-risk individuals covered under the insurance policy, increasing costs for insurers.

Question 3

You flip a coin and roll a di simultaneously.If the coin is heads up you win as many dollars as there are on the face of di.If the coin is tails, you must pay $3.You have the option to play or not.What should you do if you are a risk neutral person?

A)play
B)not play
C)it doesn't matter, the expected value is the same

A

Accepted Answer

The expected value of playing the game can be calculated as follows:
E(Winnings) = (1/2)(1+2+3+4+5+6) - (1/2)(3) = $1.5 - $1.5 = $0 
Since the expected value of playing the game is $0, a risk neutral person would be indifferent between playing or not playing. However, if the person enjoys the game or sees value in the entertainment that comes from playing, then they should choose to play.

Question 4

According to the Capital Asset Pricing Formula, if the risk free rate is 3%, the market rate of return is 6%, and Beta = .6, what is the required rate of return on the asset?&#10;A)4.8%&#10;B)6%&#10;C)3.6%&#10;D)3%

Accepted Answer

The Capital Asset Pricing Model (CAPM) formula is: Required Rate of Return = Risk-Free Rate + Beta * (Market Rate of Return - Risk-Free Rate). Plugging in the given values: Required Rate of Return = 3% + 0.6 * (6% - 3%) = 3% + 0.6 * 3% = 3% + 1.8% = 4.8%.

Question 5

Risk occurs when&#10;A)there is a known probability of random variance in the outcome of an action&#10;B)there is imperfect information about the outcome of an action&#10;C)we are uncertain about a given probability&#10;D)there are known knowns, known unknowns, and unknown unknowns

Accepted Answer

Risk occurs when there is a known probability of random variance in the outcome of an action, meaning that the likelihood of different outcomes can be quantified.

Question 6

A fair gamble is&#10;A)a risk where the participant can expect to win any amount greater than 0&#10;B)a risk where all possible outcomes are known to the participant&#10;C)a risk where the player has a 50% chance of winning and a 50% chance of losing&#10;D)a risky decision with an expected value of $0

Accepted Answer

A fair gamble is defined as a risky decision where the expected value is $0, meaning the potential gains and losses are balanced such that the average outcome over time is neutral.

Question 7

Quasi option value is the maximum a person would pay for new information that reduces&#10;A)risk&#10;B)probability of losing any money&#10;C)uncertainty&#10;D)expected value

Accepted Answer

Quasi option value is the value of new information that reduces uncertainty. The other options (A, B, and D) do not fully capture the concept of uncertainty reduction.

Question 8

Suppose you play a game where you pay $100 dollars to participate and have a 50% chance of winning nothing, a 10% chance of winning $1,100, a 20% chance of winning $600 and a 25% chance of losing $650.What is the expected value of participating in the game?

A)$100
B)$0
C)-$100
D)$1,050

Accepted Answer

The expected value (EV) is calculated by multiplying each outcome by its probability and summing these products. EV = (0.5 * $0) + (0.1 * $1,100) + (0.2 * $600) - (0.25 * $650) = $0 + $110 + $120 - $162.50 = $67.50. Since you pay $100 to participate, the net expected value is $67.50 - $100 = -$32.50. However, none of the options correctly reflects this calculation. Based on the provided options, the closest correct approach to calculating expected value would still result in none of the options being correct. The explanation provided is based on the standard method for calculating expected value, but it appears there was a mistake in my calculation. Correcting my approach: EV = (0.5 * $0) + (0.1 * $1,100) + (0.2 * $600) + (0.25 * -$650) = $0 + $110 + $120 - $162.50 = $67.50. However, considering the initial payment of $100 to participate should actually be subtracted from the winnings, not added as a separate step. The correct calculation should factor in the cost as part of the outcomes. Given the misunderstanding in the explanation, the correct expected value calculation should directly consider the outcomes relative to the cost of playing, which was not accurately reflected in the initial response.

Question 9

Suppose a person has a risk averse utility function of U(W)= √(Wealth).Also, suppose her initial wealth is $2,500.She can choose to play a game with a 50% chance of winning $1,100 and a 50% chance of losing $900.Would she choose to play the game ?

A)yes
B)no
C)she will be indifferent between playing and not playing

Accepted Answer

The answer of Suppose a person has a risk averse...

Question 10

Which line shows a risk free asset in the capital asset pricing model?&#10;A)&#946;=1&#10;B)&#946;<1&#10;C)&#946;>1&#10;D)none of the above

Accepted Answer

The CAPM model assumes there is a risk-free asset, but none of the given choices indicate a risk-free asset. Therefore, the answer is none of the above.

Question 11

Option value is the&#10;A)most a person will pay for a risky product before knowing what the outcome will be&#10;B)difference between the option price and the expected value&#10;C)net benefits of every possible policy action weighted by the odds of that outcome&#10;D)the value a person chooses to attribute to a good

Accepted Answer

The answer of Option value is the&#10;A)most a person will...

Deck 9: Risk and Uncertainty