Question 1

In the end of 2008, We Pro Ltd., a corporation, earned a profit. The profit was then reinvested into the corporation or was paid out to shareholders as dividends. The amount of dividends a shareholder would receive is tied to:

A)The shareholders' ties with the company.
B)The number of shares that investors hold.
C)The shareholders' roles and seniority within the corporation.
D)The shareholders' trust in the corporation.

The number of shares that investors hold.

Accepted Answer

Dividend is proportional to the number of shares that investors hold.
Key Takeaway: Dividends normally take the form of cash or shares in the company, depending on the company's structure.

Question 2

Which of the following types of information provide a likely opportunity to earn abnormal profits on the market?&#10;A)The latest copy of a company's annual report.&#10;B)News from the market that 100,000 shares of A&A were just traded in a single transaction.&#10;C)A top analyst that works for you advising you that he strongly believes A&A will increase its dividend soon.&#10;D)News from the market that a large new issue of the common stock of A&A Pty&#10;E)Your friend, the CEO of A&A, telling you the company is going to increase its dividend.

Accepted Answer

C and E are both examples of advanced information. However, it is likely that it would be illegal to act on E, as it is insider information.
Key Takeaway: In order to make abnormal profit, information should not be available to the public. If the information is publicized, everyone can react to make profits from this information; and there will not be abnormal profit. In answers A, B, and D, this is all information that an efficient market will be aware of.

Question 3

Britney has the following utility function:U(w)=w2. Given that the second derivative is positive, what is her attitude to risk?&#10;A)Risk-averse.&#10;B)Risk-averse at low levels of wealth and risk neutral as wealth increases.&#10;C)Risk-loving.&#10;D)Risk-averse for low levels of wealth and risk loving at higher levels of wealth.

Accepted Answer

Britney is a risk loving person, since the second derivative of her utility function is positive. Utility function in finance is a function that specifies the satisfaction of an investor for her wealth levels. It represents both his welfare and his preferences.
Key Takeaway: If there is a lottery and Britney prefers the expected value of the lottery to the lottery itself, she is risk averse. If she is indifferent between the expected value of the lottery and the lottery itself, then she is risk neutral. And if she prefers the lottery itself to the expected value of the lottery, then she is a risk lover.

Question 4

Tom has the following curve that represents his utility function. What is his attitude to risk?&#10;A)Risk averse.&#10;B)Risk neutral.&#10;C)Risk loving.&#10;D)Risk seeking.

Accepted Answer

Tom is risk averse. If there is a lottery, Tom prefers the expected value of the lottery to the lottery itself. His utility function reflects his satisfaction for his wealth level and represents his welfare and preferences. Concave utility function shows that each increase in wealth conveys progressively smaller increase to utility.
Key Takeaway: Tom has his utility function concave to the origin because he is risk averse. For a risk neutral investor, his utility function is convex to the origin. For a risk lover, his utility function is a straight line.

Question 5

What is the meaning of standard deviation? Select all that apply.&#10;A)It measures the degree of spread. The bigger it is, the more likely to find oneself from the mean.&#10;B)It is the square root of the variance.&#10;C)It provides a crude measure of risk.&#10;D)All of the above.

Accepted Answer

The standard deviation provides a rough measure of risk by measuring the degree of spread from the mean. It is also the square root of the variance.
Key Takeaway: When a portfolio has low standard deviation, it means that it is less risky. When the portfolio has high standard deviation, it is more risky. Standard deviation is a measure of "volatility."

Question 6

Mike is a gambler. He's been offered a fair gamble. How will he likely behave?&#10;A)Roll the dice, baby!&#10;B)He would have to further analyze the risk reward curve.&#10;C)No fun . . . Mike would pass.&#10;D)He would not gamble, because the expected value is zero.

Accepted Answer

Mike will roll the dice. A gambler tends to accept fair gambles, while a risk-averse person would refuse it.
Key Takeaway: While this is the terminology, remember that the distribution of outcomes is typically a far more important determinant. Mike might like to gamble when the chances of winning are 50/50, but if the gamble is $1 billion versus certain death, he might be less of a gambler.

Question 7

Jenny is a gambler who has a utility function that is &#34;more concave&#34; or &#34;curvier&#34; than Tom's utility function. Who is more risk averse?&#10;A)Jenny.&#10;B)Tom.&#10;C)Both are equal.&#10;D)None.

Accepted Answer

Jenny is more risk averse than Tom because her utility function is curvier. As she is more risk averse than Tom, she loses more than Tom when risk is introduced.
Key Takeaway: Both Jenny and Tom are risk averse investors who, when faced with two investments with the same expected return but two different risks, prefer the one with the lower risk.

Question 8

A risk has two components: uncertainty and exposure. Interest rate risk is therefore a risk to the earnings or market value of a portfolio due to&#10;A)Exposure to interest rate fluctuations.&#10;B)Uncertainty in interests.&#10;C)Exposure to uncertain current interest rates.&#10;D)Uncertain future interest rate.

Accepted Answer

Interest rate risk is a risk to the earnings or market value of a portfolio due to uncertain future interest rates. Future interest rates are uncertain and unpredictable. Therefore, an exposure to interest rates leads to a risk.
Key Takeaway: If future interest rates can be forecast and anticipated, then the level of risk can be reduced.

Question 9

You are a U.S. investor and you have stocks in France. The return that you will get is affected by both the change in the price of the stocks and the change of the Euro against the U.S. dollar. What kind of risk does this refer to?

A)Foreign exchange risk.
B)Liquidity risk.
C)Interest rate risk.
D)Geopolitical risk.

Accepted Answer

This is a case of foreign exchange risk, also known as currency risk. It is a form of risk that arises from the change in the price of one currency against another. This risk usually affects businesses that export and/or import and investors who makes international investments.
Key Takeaway: Whenever you have assets or business operations across national borders, you face currency risk if your positions are not hedged. Currency hedging (also known as Foreign Exchange Risk hedging) is used to reduce the risks encountered when investing abroad.

Question 10

What is inflation risk?&#10;A)The increase in prices of good and services in the economy.&#10;B)The risk that the value of assets or income will decrease.&#10;C)The risk that inflation will get out of control to become hyperinflation.&#10;D)The risk that is due to uncertainty of inflation.

Accepted Answer

Inflation risk is the possibility that the value of assets or income will decrease as inflation reduces the purchasing power of the currency. Inflation happens when the overall general price of goods and services in an economy moves upward. It is usually measured by the Consumer Price Index and the Producer Price Index in the US. Severe inflation causes loss of confidence, less investment, and economic instability because the purchasing power of the currency erodes as prices increase. Therefore, inflation involves the risk that the value of assets or incomes will decrease. The higher the inflation rate, the more risk it involves.
Key Takeaway: Zimbabwe's rate of inflation surged to 3,732% in 2008. Hope you weren't holding Zimbabwe dollars.

Question 11

In 2009, Deutsche Bank warned that the UAE might face deflation, which is a general decline in overall prices. Which of the following is the result of deflation?&#10;A)Shrinking employment.&#10;B)Decrease in income.&#10;C)Defaults on loans.&#10;D)Economic recession.&#10;E)All of the above.

Accepted Answer

The answer of In 2009, Deutsche Bank warned that the...

Question 12

A systemic risk is a risk that affects an entire financial market or system--not just a specific section. It is possible to avoid the systemic risk through diversification.

Accepted Answer

The answer of A systemic risk is a risk that...

Deck 5: Dividend, Profit, and Risk