Question 1

Following a decrease in the risk-free rate, the certainty equivalent adjustment factor will:&#10;A)rise for risk adverse investors.&#10;B)fall for risk adverse investors.&#10;C)fall for risk seeking investors.&#10;D)none of these.

Accepted Answer

D

Question 2

If profits are normally distributed with a mean of &#8364;5,000 and a standard deviation of &#8364;500, there is only a 2.5% chance actual profits will exceed:&#10;A)&#8364;4,000.&#10;B)&#8364;5,000.&#10;C)&#8364;6,000.&#10;D)&#8364;6,500.

Accepted Answer

Given that profits are normally distributed, we can use the empirical rule or z-scores to determine the probability of profits exceeding a certain amount. A 2.5% chance of exceeding a value corresponds to a z-score of approximately 1.96 (or -1.96 for the lower tail), which represents about 2 standard deviations from the mean in a normal distribution. The mean is €5,000 and the standard deviation is €500, so 2 standard deviations above the mean is €5,000 + 2(€500) = €6,000. This means there's a 2.5% chance that profits will exceed €6,000.

Question 3

Global investors who suffer the loss of favoured trade status experience:&#10;A)government policy risk.&#10;B)derivative risk.&#10;C)cultural risk.&#10;D)currency risk.

Accepted Answer

The loss of favoured trade status is typically the result of changes in government policy, which can create uncertainty and higher risk for global investors. This falls under the category of government policy risk. Derivative risk refers to the possibility of losses arising from changes in the value of financial instruments such as options, futures, or swaps. Cultural risk can arise from differences in language, customs, or attitudes towards business, while currency risk refers to the possibility of losses due to changes in exchange rates. The loss of favoured trade status is primarily an issue of government policy risk, as it reflects a change in the laws and regulations that affect international trade. This can lead to higher tariffs, trade barriers, and other unfavorable conditions that can hurt investors who have previously relied on the benefits of favored trade status. Derivative risk, cultural risk, and currency risk may also be factors in some cases, but they are not the primary drivers of this particular issue.

Question 4

When the risk-adjusted discount model employs certainty equivalent adjustment factors, risk aversion is implied if:&#10;A)< 1 and k < i.&#10;B)< 1 and the k > i.&#10;C)= 1 and the k equals the risk-free rate of return.&#10;D)none of these.

Accepted Answer

The answer of When the risk-adjusted discount model employs certainty...

Question 5

Risk aversion is implied when the certainty equivalent adjustment factor:&#10;A)> 1.&#10;B)= 1.&#10;C)< 1.&#10;D)> 1, but falling.

Accepted Answer

When the certainty equivalent adjustment factor is less than 1, it means that the individual is willing to give up some potential gain to avoid risk, indicating risk aversion. Therefore, choice C is the best answer. A certainty equivalent adjustment factor of less than 1 implies risk aversion. This means that an individual would need more than the risky option's expected return in order to be willing to take on that risk. Thus, the answer is C - when the certainty equivalent adjustment factor is less than 1.

Question 6

In the risk-adjusted discount rate approach, increasing risk aversion is reflected in a cost of capital that exceeds the:&#10;A)risk-free rate.&#10;B)risk free rate and falls with increasing risk.&#10;C)risk free rate and falls with decreasing risk.&#10;D)none of these.

Accepted Answer

In the risk-adjusted discount rate approach, increasing risk aversion leads to a higher cost of capital that exceeds the risk-free rate and decreases as the perceived risk decreases.

Question 7

Economic risk:&#10;A)is the chance of loss because all possible outcomes are unknown.&#10;B)exists when the outcomes of managerial decisions cannot be predicted with absolute accuracy but all possibilities and their associated probabilities are known.&#10;C)allows for informed managerial decisions.&#10;D)can be directly reflected in the basic valuation model of the firm.

Accepted Answer

Economic risk refers to the uncertainty surrounding the outcomes of managerial decisions, where all possible outcomes and their associated probabilities are not known. This lack of knowledge creates the potential for losses, making economic risk a major concern for managers. Additionally, economic risk cannot be directly reflected in the basic valuation model of the firm, further highlighting its unpredictable nature. Economic risk refers to the uncertainty of outcomes because all possible scenarios and their associated probabilities are not known. This can make it difficult for managers to make informed decisions and can increase the likelihood of loss. It cannot be directly reflected in the basic valuation model of the firm, as that model relies on known and predictable factors.

Question 8

For two projects of differing sizes, the project that is relatively more risky has the:&#10;A)highest standard deviation.&#10;B)highest expected profit.&#10;C)highest coefficient of variation.&#10;D)lowest coefficient of variation.

Accepted Answer

The coefficient of variation measures the relative risk of a project by calculating the standard deviation as a percentage of the mean. Therefore, the project that is relatively more risky will have a higher coefficient of variation. The other options are not necessarily indicative of relative risk. The coefficient of variation (CV) measures the relative risk of a project, taking into account the project's standard deviation and expected value. The higher the CV, the more risky the project is relative to its expected value. Therefore, for two projects of differing sizes, the project that is relatively more risky will have the highest coefficient of variation.

Question 9

The chance of loss because of overall swings in the financial markets does not include:&#10;A)market risk.&#10;B)interest rate risk.&#10;C)liquidity risk.&#10;D)expropriation risk.

Accepted Answer

Expropriation risk refers to the chance of loss due to the government taking control of assets or property, rather than overall swings in the financial markets. Market risk, interest rate risk, and liquidity risk are all types of risk related to market fluctuations and overall economic conditions. Expropriation risk refers to the possibility of a government seizing private property without proper compensation. It is not related to overall swings in the financial markets, and therefore, is not a type of market risk. A, B, and C are all types of market risks.

Question 10

For two projects with the same cost, the one that is more risky has the:&#10;A)lowest standard deviation.&#10;B)lowest expected profit.&#10;C)highest standard deviation.&#10;D)highest expected profit.

Accepted Answer

A higher level of risk will result in a higher standard deviation, indicating a wider range of potential outcomes. Therefore, the project with more risk will have a higher standard deviation than the project with less risk. However, a higher level of risk also has the potential for higher expected profit, so the project with more risk may also have a higher expected profit. Therefore, the correct answer is C, which is the choice that indicates the highest standard deviation, but does not make any assumptions about the expected profit. Risk and standard deviation are directly related. The more risky a project is, the higher its standard deviation will be. Therefore, the project with the higher standard deviation (Choice C) is the more risky option.

Deck 16: Risk Analysis