Deck 19: Decisions Involving Uncertainty

Question 1

People face risk whenever:

A)there are several certain outcomes, but a choice must be made.
B)there is a lack of uncertainty about a situation or choice.
C)they do not know with certainty what the outcome of a situation or choice will be.
D)there is more than one option.

Answer 1

C

Question 2

The two essential elements of risk are _____ and _____.

A)choices; consequences
B)consequences; hedging
C)payoffs; hedging
D)probabilities; payoffs

Answer 2

D

Question 3

A fair bet is a:

A)wager entered into with honesty and concern for the welfare of the other party.
B)wager entered into when the rules are clear to all participants.
C)gamble that, on average, will leave a person with the same amount of money.
D)gamble that provides net gains to all participants so there is no loser.

Answer 3

C

Question 4

A gamble that, on average, will leave a person with the same amount of money is known as:

A)a zero gain bet.
B)a fair bet.
C)an equal option.
D)an equity wager.

Question 5

Marta is considering the purchase of a condominium. Which of the following would be a gamble that is a fair bet?

A)The condo has a 10% probability of rising in value by 20% and a 10% probability of falling in value by 30%.
B)The condo has a 10% probability of rising in value by 30% and a 30% probability of falling value by 5%.
C)The condo has a 10% probability of rising in value by 15% and a 15% probability of falling in value by 10%.
D)The condo has a 10% probability of rising in value by 30% and a 15% probability of falling value by 30%.

Question 6

Merced is considering an investment that has a 50% probability of rising in value by 60% and a 50% probability of falling value by 40%. Is this a fair bet?

A)Yes, the odds are that Merced will gain a positive return.
B)Yes, the odds are that Merced will break even.
C)No, the odds are that Merced will gain a positive return.
D)No, the odds are that Merced will have a negative return.

Question 7

A risk-averse person is someone who:

A)changes direction when there is risk.
B)seeks risk in order to gain return.
C)keeps returning to higher risk.
D)dislikes uncertainty.

Question 8

What is true about risk-averse people and fair bets?

A)Risk-averse people will accept a fair bet.
B)Risk-averse people will reject a fair bet.
C)Risk-averse people will renegotiate an unfair bet to make it fair before accepting it.
D)Risk-averse people will not accept any uncertainty, even if the bet is fair.

Question 9

Bishan is risk averse. This means he would consider only one of the following options, immediately rejecting all of the others. Which one would Bishan consider?

A)a 50% chance of a 20% return and a 50% chance of a 30% loss
B)a 50% chance of a 20% return and a 50% chance of a 20% loss
C)a 40% chance of a 20% return and a 60% chance of a 15% loss
D)a 40% chance of a 20% return and a 60% chance of a 10% loss

Question 10

Mathematically, a fair bet has an expected return of:

A)anything above zero.
B)the current interest rate or higher.
C)zero.
D)anything from negative to positive, but the exact return is known in advance with certainty.

Question 11

If an investment has a 40% probability of a 20% return and a 60% probability of a 10% loss, then the expected return would be:

A)an 8% gain.
B)a 6% loss.
C)a 2% loss.
D)a 2% gain.

Question 12

In a fair bet, the:

A)outcome is known in advance so there is no uncertainty.
B)expected return is high enough to induce risk-averse people to accept the risk.
C)expected winnings exactly offset the expected losses.
D)expected winnings are greater than the expected losses.

Question 13

A person who dislikes uncertainty is known as a _____ person.

A)fair bet
B)risk-averse
C)payoff
D)negative

Question 14

A person's utility level is his or her:

A)level of health.
B)usefulness.
C)overall degree of risk aversion.
D)overall level of well-being.

Question 15

Which of the following statements about the marginal utility of wealth is accurate?

A)Marginal utility of wealth is high when a person is poor and diminishes as wealth increases.
B)Marginal utility of wealth is low when a person is poor and rises as wealth increases.
C)Marginal utility of wealth holds steady as wealth changes, but total utility changes as wealth changes.
D)Marginal utility of wealth is the total utility gained from a person's wealth.

Question 16

The marginal utility of an extra dollar is:

A)the change in usefulness that comes from extra income.
B)determined by the source of the dollar.
C)the change in economic status that comes from an overall level of wealth.
D)the extra satisfaction you would get from having one more dollar.

Question 17

The slope of a utility function is:

A)positive and increasing.
B)positive and diminishing.
C)negative and increasing.
D)negative and diminishing.

Question 18

The utility function for wealth indicates that:

A)there is a negative relationship between wealth and total utility.
B)total utility falls as wealth rises.
C)marginal utility falls as wealth rises.
D)marginal utility rises as wealth rises.

Question 19

What principle explains why the utility function gets flatter as wealth rises?

A)the law of demand
B)cost analysis
C)the risk-reward trade-off
D)diminishing marginal utility

Question 20

Your marginal utility would be highest at which of the following wealth levels?

A)$10,000
B)$50,000
C)$100,000
D)$500,000

Question 21

Diminishing marginal utility makes people:

A)wealthy.
B)risk averse.
C)less prosperous.
D)risk neutral.

Question 22

How does a gain of $1,000 versus a loss of $1,000 impact a person's utility?

A)The gain and loss have equal impact on utility but in opposite directions.
B)The gain would have greater impact on utility than the loss.
C)The loss would have greater impact on utility than the gain.
D)Gaining or losing money has no impact on utility.

Question 23

Shantelle faces a risk where she has equal chance of either gaining $2,000 or losing $2,000. Which of the following statements describes her view of the risk if she is risk averse?

A)Losing $2,000 would diminish her well-being more than gaining $2,000 would raise it.
B)Losing $2,000 would diminish her well-being less than gaining $2,000 would raise it.
C)Losing $2,000 would diminisher her well-being just as much as gaining $2,000 would raise it.
D)Both options would have the same impact on her well-being so she is indifferent.

Question 24

When considering diminishing marginal utility, how do the costs compare to the benefits of a fair bet?

A)The costs and benefits are equal in size and in the same direction.
B)The costs and benefits are equal in size but in opposite directions.
C)The drop in utility due to losses exceeds the increase in utility due to gains.
D)The drop in utility due to losses is less than the increase in utility due to gains.

Question 25

Which income change would cause Martin's utility level to change by the largest absolute amount?

A)$2,000 gain
B)$1,000 gain
C)$1,000 loss
D)$2,000 loss

Question 26

When looking at utility rather than money, what does the outcome of a fair bet look like?

A)The potential drop in utility is greater than the potential increase in utility.
B)The potential drop in utility is smaller than the potential increase in utility.
C)The potential drop in utility is equal to the potential increase in utility.
D)There is no expected change in utility.

Question 27

What of the following principles explains why a fair bet would, on average, cause a drop in well-being for a risk-averse individual?

A)diversification
B)hedging
C)diminishing marginal utility
D)demand and supply

Question 28

Cost-benefit analysis indicates that a person should make an investment if the:

A)utility value of its average exceeds its average returns.
B)utility value of its average returns exceeds its average losses.
C)monetary value of its returns exceeds its losses.
D)monetary value of its losses exceeds its returns.

Question 29

There is a trade-off between _____ and _____.

A)money; benefits
B)money; utility
C)decisions; certainty
D)risk; return

Question 30

(Figure: Utility Function) Use the utility function graph to answer the question.
Jo has income of $40,000. She is faced with an opportunity that has an equal chance of resulting in an additional $10,000 in income or a loss of $10,000 in income. Using expected utility as the deciding factor, should Jo pursue the opportunity?

A)Yes, the potential increase in utility is larger than the potential decrease in utility.
B)No, the potential increase in utility is less than the potential decrease in utility.
C)It is a toss-up because her expected rise in utility exactly offsets her expected loss in utility.
D)She can expect her utility to remain unchanged regardless of what she does.

Question 31

(Figure: Utility Function) Use the utility function graph to answer the question.
Olga has income of $30,000. She has an opportunity that has a 50% chance of increasing her income by $20,000 and a 50% chance of decreasing her income by $10,000. Which of the following is true regarding this opportunity and her utility?

A)The potential loss in utility exceeds the potential gain in utility.
B)The potential loss in utility is less than the potential gain in utility.
C)The potential change in utility is the same, just in opposite directions.
D)Her utility is unaffected by changes in income.

Question 32

Chin is extremely risk averse. This means that his utility function will have a _____ slope that _____ becomes more horizontal as his wealth rises.

A)negative; slowly
B)negative; rapidly
C)positive; slowly
D)positive; rapidly

Question 33

Hua Xing is mildly risk averse. This means that her utility function will have a _____ slope that _____ becomes more horizontal as her wealth rises.

A)negative; slowly
B)negative; rapidly
C)positive; slowly
D)positive; rapidly

Question 34

(Figure: Utility Functions) Which utility function represents the most risk-averse person?

A)Utility function A
B)Utility function B
C)Utility function C
D)Utility function D

Question 35

(Figure: Utility Functions) Which curve is a utility function for a slightly risk-averse person?

A)Utility function A
B)Utility function B
C)Utility function C
D)Utility function D

Question 36

The more risk averse a person is, the:

A)more willing they are to suffer a loss.
B)less willing they are to suffer a loss.
C)more eager they are to have a gain.
D)more indifferent they feel about investment decisions.

Question 37

The more risk averse people are, the:

A)less they try to gain.
B)less they try to avoid loss.
C)more they try to gain.
D)more they try to avoid loss.

Question 38

If a person is highly risk averse, the _____ marginal utility associated with a negative outcome outweighs the _____ marginal utility from a positive outcome.

A)lower; higher
B)higher; lower
C)lower; lower
D)higher; higher

Question 39

Risk aversion is evident in what types of decisions?

A)financial and occupational but not relationships or health
B)relationships and health but not financial or occupational
C)financial but not occupational, relationships, or health
D)financial, occupational, relationships, and health

Question 40

A person's willingness to accept a given risk-reward combination reflects his or her level of _____, which depends on the person's _____ and _____.

A)utility; income; goals
B)risk aversion; goals; temperament
C)utility; goals; occupation
D)risk aversion; temperament; life situation

Question 41

When deciding whether to take a risk, Janelle's decision should depend on what three factors?

A)Janelle's income, level of risk aversion, and needs
B)Janelle's income, her level of reward, and whether the stakes are high or low
C)Janelle's level of risk aversion, the risk-reward ratio, and whether the stakes are high or low
D)Janelle's income, level of risk aversion, and wants

Question 42

Which of the following is NOT one of the three factors that you should consider in deciding whether to take a risk?

A)whether the stakes are high or low
B)your degree of risk aversion
C)the size of the risk relative to the reward
D)the level of wealth

Question 43

If Kono makes a particular choice, his utility, on average, is his:

A)total well-being.
B)normal well-being.
C)middle utility.
D)expected utility.

Question 44

Expected utility is:

A)the utility level a person hopes to achieve if all goes as expected.
B)a person's utility, on average, if he or she makes a particular choice.
C)the average level of utility across a population.
D)the standard level of utility used to determine if a person is happier or less happy than anticipated.

Question 45

The expected utility of a choice is calculated as:

A)the anticipated level of utility of the choice based on the spread between the best and worst possible outcomes.
B)the change in utility that will occur based on the difference between the pre-choice and post-choice utility levels.
C)a weighted average of the different utility levels associated with each possible outcome, weighted by the probability that outcome occurs.
D)the total of all possible utility levels resulting from the choice divided by the number of possible utility levels.

Question 46

When a choice is being considered, the _____ of that choice is the weighted average of the different utility levels associated with each possible outcome, weighted by the probability that outcome occurs.

A)expected utility
B)anticipated utility
C)marginal well-being result
D)normed utility result

Question 47

A choice with two possible outcomes is being considered. The expected utility of that choice is equal to:

A)(Utility of outcome 1 + Utility of outcome 2) / 2.
B)((Probability of outcome 1) × (Utility of outcome 1)) + ((Probability of outcome 2) × (Utility of outcome 2)).
C)((Probability of outcome 1) - (Utility of outcome 1)) + ((Probability of outcome 2) - (Utility of outcome 2)).
D)(Utility of outcome 1 / Probability of outcome 1) + (Utility of outcome 2 / Probability of outcome 2).

Question 48

Lela must decide whether to go on a winter trip to Norway with the hope of seeing the Northern Lights. Seeing the lights would yield a utility level of 2,000, but she has only a 50% chance that they will show during the days of her trip. Making the trip without seeing the lights would yield a utility level of 100, and there is 50% chance of this happening. What is Lela's expected utility if she goes on the trip?

A)2,100
B)42
C)950
D)1,050

Question 49

Sven is considering a fishing trip. If there is good weather, his utility gained from the trip will be worth $900. If the weather is bad, his utility from the trip will be worth -$300. There is a 60% chance of bad weather and a 40% chance of good weather. What is Sven's expected utility for the fishing trip?

A)$240
B)-$180
C)$180
D)$360

Question 50

Lek is deciding whether to enter a contest. If she wins, her rise in utility will be worth $10,000. If she loses, her change in utility would be worth -$500. She has a 5% chance of winning and a 95% chance of losing. What is Lek's expected utility if she participates in the contest?

A)-$475
B)$25
C)$500
D)$525

Question 51

Assad has an opportunity to enter a contest. If he wins the contest, the value of his increase in utility will be $6,000. If he loses the contest, the value of his decrease in utility will be -$300. His probability of winning is 4%. His probability of losing is 96%. What is Assad's expected utility if he enters the contest?

A)$192
B)$240
C)$288
D)-$48

Question 52

Why do people gamble?

A)They have a greater chance of winning money than losing it.
B)They are willing to pay for the entertainment value of the experience.
C)They are risk averse.
D)The expected earnings provide a positive return.

Question 53

Markus is considering an investment that has a 30% chance of providing a value in utility worth $20,000 and a 70% chance of incurring a loss of utility worth $7,000. What is Markus's expected utility from this investment?

A)$4,900
B)$1,100
C)$10,900
D)$6,000

Question 54

Anneke is considering a hiking vacation in the mountains. If the weather is good, she will gain utility valued at $3,000 from the trip. If the weather is bad, she will lose utility valued at $2,000. The weather has a 40% chance of being good and a 60% chance of being bad. What is Anneke's expected utility if she goes on the trip?

A)$0
B)$2,500
C)$1,200
D)$2,400

Question 55

Anna is considering an investment that has a 50% chance of providing a positive return of utility worth $5,000 and a 50% chance of a loss of utility worth $5,000. When the probability of a positive return rises to 60% and a negative return falls to 40%, her expected utility rises from _____ to _____.

A)$1,000; $3,000
B)$0; $2,500
C)$2,500; $3,000
D)$0; $1,000

Question 56

Which of the following is NOT a strategy for reducing risk?

A)hedging
B)gathering information
C)specialization
D)risk spreading

Question 57

Which of the following is NOT a strategy that you could use to reduce risk?

A)diversification
B)dominance
C)insurance
D)risk spreading

Question 58

Which of the following is NOT a strategy that Jolene could use to reduce her risk?

A)insurance
B)gathering information
C)verification
D)hedging

Question 59

Each of the following is a strategy for reducing risk EXCEPT:

A)hedging.
B)gathering information.
C)insurance.
D)magnification.

Question 60

Risk spreading is:

A)making a deep risk appear thinner.
B)creating a broader set of potential losers.
C)reducing the number of potential winners.
D)transforming big risks into small risks to be spread over many people.

Question 61

Splitting up big risks into many small risks is called:

A)diminishing risk.
B)risk spreading.
C)risk break-up.
D)risk minimizing.

Question 62

Breaking a big risk into many smaller risks so that it can be spread over many people is known as:

A)risk dilution.
B)risk spreading.
C)risk division.
D)horizontal risk division.

Question 63

Marta has an idea for a new product that could earn $1 million if successful. It would cost $600,000 to bring it to market, and that is the potential loss if it fails. Marta estimates that it has a 60% chance of success and 40% chance of failure. Marta is not willing to accept the risk of failure. She enlists 1,000 investors to each put in $600 toward the cost with a promise that they will share proportionately in the profits. What risk reduction strategy is Marta using?

A)hedging
B)diversification
C)risk spreading
D)insurance

Question 64

Why are people less willing to make a large investment than a small investment when both investments carry the same probabilities of success versus failure as well as the same rates of return?

A)The risk level is positively related to the number of investors.
B)If a large investment is broken into smaller parts, the return rates grow.
C)The potential positive impact on wealth and utility is much greater with a large investment.
D)The potential negative impact on wealth and utility is much greater with a large investment.

Question 65

People tend to make _____ choices when the stakes are large and _____ choices when the stakes are small.

A)risk-loving; risk-neutral
B)risk-averse; nearly risk-neutral
C)risk-averse; risk-loving
D)nearly risk-neutral; risk-averse

Question 66

How is Jamal's wealth affected by an investment when the stakes are small?

A)It is impacted by a great deal in either a positive or a negative direction.
B)It is affected more if the probability is great than if the probability is small.
C)It is affected by a small amount in either a positive or a negative direction.
D)It is impacted more if the return is positive than if it is negative.

Question 67

JoJo is risk neutral when she:

A)faces an opportunity with equal probabilities of success and failure.
B)faces an opportunity with equal expected negative and positive changes in utility.
C)has no sense of positive or negative utility.
D)is indifferent to uncertainty.

Question 68

If you are indifferent to uncertainty, you are referred to as:

A)uncommitted.
B)risk neutral.
C)an impartial utilitarian.
D)not risk averse.

Question 69

What is the deciding factor in an investment decision when the investor is risk neutral?

A)whether the average financial returns on the investment are positive
B)whether the rate of return is greater than the probability of a positive outcome
C)whether the outcome is positive or negative
D)whether the expected utility of the investment is greater than the financial return

Question 70

It is appropriate to take any risk that is better than a fair bet when:

A)risk aversion is high.
B)risk is high.
C)the stakes are small enough.
D)the stakes are large.

Question 71

Risk spreading explains why most large companies have:

A)low profit rates.
B)high profit rates.
C)few shareholders.
D)many shareholders.

Question 72

Reducing risk by combining a large number of small risks whose outcomes are not closely related is called:

A)risk-spreading.
B)hedging.
C)gambling.
D)diversification.

Question 73

Diversification is:

A)breaking a big risk into many smaller risks so that it can be spread over many people.
B)reducing risk by combining a large number of small risks whose outcomes are not closely related.
C)a gamble that, on average, allows the risk to be spread out into small parts to make it smaller.
D)a reduction in risk that comes from changing the nature of risk into something else that is less risky.

Question 74

What impact does diversification have on the risk Andrew faces?

A)Each new option has less risk, but the combined total risk may be greater.
B)Risk rises, falls, and then returns to its original level.
C)Risk is reduced.
D)Risk is increased.

Question 75

Maria is a senior at a university and wants to have a job lined up to begin working the month after she graduates. She has identified three companies that have openings that she describes as her "dream job" and many companies that offer career-track positions in her field. Which of the following actions would give her the lowest risk of not having a job arranged to begin a month after graduation?

A)She should apply only at the companies that offer her "dream job."
B)She should apply at the companies offering her "dream job" and three other companies with job openings in her field.
C)She should apply at the companies offering her "dream job" and 50 other companies with job openings in her field.
D)She should apply at 50 companies with job openings in her field.

Question 76

Chantelle has $20,000 to invest in stocks. She wants to diversify her investments to reduce her risk as much as possible. Which mix of investments would give her the most diverse portfolio?

A)She should put all $20,000 into a chosen company.
B)She should invest in the leading five companies in a chosen industry.
C)She should invest in the leading company in five different industries.
D)She should invest in carefully selected companies in 10 different industries.

Question 77

A key issue in reducing risk through diversification is to make sure that the risks:

A)all carry a low return.
B)all are as high as possible.
C)that are being combined are different.
D)that are being combined are similar.

Question 78

An investment that automatically invests in a predefined portfolio of stocks is known as _____ fund.

A)an index
B)a set-mix
C)a definition
D)a grouped

Question 79

Risks that are common across the whole economy are known as:

A)common risks.
B)integrated risks.
C)wide-deep risks
D)systematic risks.

Question 80

A systematic risk is a risk that:

A)affects the decision maker's most vulnerable assets.
B)is common across the whole economy.
C)would change the relationships between factors.
D)intensely focuses on one relationship.