Deck 14: Managerial Decision-Making Under Uncertainty

Question 1

If an event is certain to occur, it has a probability (pr)of

A)0.
B)0 < pr < 1.
C)1.
D)Not enough information to determine.

Answer 1

1.

Question 2

Probability

A)is a number between 0 and 1, inclusive.
B)indicates how likely an outcome is to occur.
C)is larger the more likely the event is to occur.
D)All of the above.

Answer 2

All of the above.

Question 3

People in a certain group have a 0.3% chance of dying this year. If a person in this group buys a life insurance policy for $3,300 that pays $1,000,000 to her family if she dies this year and $0 otherwise, what is the expected value of a policy to the insurance company?

A)$0
B)$300
C)$3,000
D)$3,300

Answer 3

$300

Question 4

Although he is very poor, Al plays the million-dollar lottery everyday because he is certain that one day he will win. Al makes this calculation based upon

A)the frequency of past outcomes.
B)subjective probability.
C)knowledge of all possible outcomes.
D)tossing a coin.

Question 5

Best guesses of an event occurring in the future are based on

A)estimates derived from the frequency of the event occurring in the past.
B)coin flips.
C)subjective probability.
D)the wisdom of crowds.

Question 6

Which of the following sets of outcomes is exhaustive?

A)win, lose, tie
B)employed full-time, employed part-time, unemployed
C)married, single, widowed
D)All of the above.

Question 7

If an event is likely to occur, which probability is a reasonable estimate?

A)0.32
B)0.79
C)1
D)Not enough information to determine.

Question 8

If outcomes are ________, exactly one of the outcomes will occur and the probabilities add up to ________.

A)probabilistic; between 0 and 1
B)exhaustive and mutually exclusive; 1
C)exhaustive; 1
D)mutually exclusive; between 0 and 1

Question 9

You draw colored balls out of a bag. You draw a red ball 30% of the time and a blue ball 70% of the time. For each draw, the blue outcome and the red outcome are

A)mutually exclusive.
B)exhaustive.
C)Both A and B.
D)None of the above.

Question 10

On any given day, a salesman can earn $0 with a 20% probability, $100 with a 40% probability, or $300 with a 20% probability. His expected earnings equal

A)$0.
B)$100 because that is the most likely outcome.
C)$100 because that is what he will earn on average.
D)$200 because that is what he will earn on average.

Question 11

Your friend Dimitre tells you that he thinks that his favorite basketball team has a 70% chance of winning the next game. This is an example of a(n)

A)objective probability.
B)subjective probability.
C)risk-averse statement.
D)Friedman-Savage preference.

Question 12

Which of the following sets of outcomes is mutually exclusive?

A)win, lose, tie
B)employed full-time, employed part-time, unemployed
C)married, single, widowed
D)All of the above.

Question 13

Sarah buys little stuffed animals for $5 each. They come in different varieties. If the producer stops making (retires)a certain variety, a stuffed animal of that variety will be worth $100; otherwise it is worth $0. There is 50% chance that any variety will be retired. When Sarah buys her next stuffed animal, the expected value is

A)$50.
B)$47.50.
C)$45.00.
D)$0.

Question 14

On any given day, a salesman can earn $0 with a 30% probability, $100 with a 20% probability, or $300 with a 50% probability. His expected earnings equal

A)$0.
B)$100.
C)$150.
D)$170.

Question 15

If an event will NOT occur, it has a probability (pr)of

A)0.
B)0 < pr < 1.
C)1.
D)Not enough information to determine.

Question 16

Expected value represents

A)the actual payment one expects to receive.
B)the average of all payments one would receive if one undertook the risky event many times.
C)the payment one receives if he or she makes the correct decision.
D)the payment that is most likely to occur.

Question 17

On any given day we know a salesman can earn $0 with a 30% probability, $100 with a 20% probability or $300 with 40% probability. His expected earnings equal

A)$0.
B)$140.
C)$300.
D)It cannot be determined from the available information.

Question 18

A(n)________ relates each possible outcome to its probability of occurrence.

A)probability distribution
B)frequency
C)expected value
D)coin toss

Question 19

If there are 10,000 people in your age bracket, and 10 of them died last year, an insurance company believes that the probability of someone in that age bracket dying this year would be

A)0.
B).001.
C).0001.
D)1,000.

Question 20

If an event is unlikely to occur, which probability is a reasonable estimate?

A)0
B)0.23
C)0.82
D)Not enough information to determine.

Question 21

Sarah buys little stuffed animals for $5 each. They come in different varieties. If the producer stops making (retires)a certain variety, a stuffed animal of that variety will be worth $100; otherwise it is worth $0. There is 50% chance that any variety will be retired. For the purchase of an individual stuffed animal, what is the value to Sarah of knowing ahead of time whether the variety will be retired?

A)$50
B)$5
C)$2.50
D)$0

Question 22

On any given day, a salesman can earn $0 with a 20% probability, $100 with a 40% probability, or $300 with a 20% probability. Calculate the expected value and variance of his earnings, and interpret.

Question 23

Variance is a measure of ________ and the higher the variance, ________.

A)expected profit; the greater the profit
B)risk; the greater the risk
C)standard deviation; greater the standard deviation
D)risk; the lower the risk

Question 24

A fair bet is one where

A)the player has a 50/50 chance of winning.
B)the player's utility function is convex.
C)the expected value is zero.
D)the expected value is positive.

Question 25

Someone who is risk-averse has

A)diminishing marginal utility of wealth.
B)constant marginal utility of wealth.
C)increasing marginal utility of wealth.
D)less marginal utility of wealth than someone who is risk-neutral.

Question 26

John's utility from an additional dollar increases more when he has $1,000 than when he has $10,000. From this, we can conclude that John

A)is risk averse.
B)is risk loving.
C)is risk neutral.
D)has a negative marginal utility of wealth.

Question 27

Rahul has a concave utility function. Therefore, if there are two choices he will pick the ________ if ________ expected value.

A)fair bet; both have the same
B)less risky choice;both have the same
C)more risky choice; both have the same
D)less risky choice; it has a lower

Question 28

For a given expected value, the smaller the standard deviation of the expected value, the larger the risk.

Question 29

Which of the following games involving the roll of a single die is a fair bet?

A)Bet $1 and receive $1 if 3 or 4 comes up.
B)Bet $1 and receive $1 if 3, 4, or 5 comes up.
C)Bet $1 and receive $4 if 6 comes up.
D)None of the bets is a fair bet.

Question 30

The key economic difference between expected utility and expected value is that

A)expected value only considers the value of outcomes, whereas expected utility considers the tradeoff between value and risk.
B)expected utility only considers the value of outcomes, whereas expected value considers the tradeoff between value and risk.
C)expected utility is the maximum value obtained, whereas expect value is the mean of the values from a set of possible outcomes.
D)None of the above-the differences are mathematical not economic.

Question 31

From the expected value of a game, we

A)cannot determine the risk.
B)can determine the risk.
C)can determine exactly how much a player will receive.
D)can infer the subjective probabilities of each possible outcome.

Question 32

John derives more utility from having $1,000 than from having $100. From this, we can conclude that John

A)is risk averse.
B)is risk loving.
C)is risk neutral.
D)has a positive marginal utility of wealth.

Question 33

Expected value represents the average of all outcomes if one were to undertake the risky event many times over and over again.

Question 34

A risk premium

A)is required to get a risk-neutral person to make a fair bet.
B)is the maximum amount needed to compensate a decision-maker to willingly take a risk.
C)is the maximum amount a decision-maker would pay to avoid taking a risk.
D)is the minimum amount a decision-maker would pay to avoid taking a risk.

Question 35

Sarah buys little stuffed animals for $5 each. They come in different varieties. If the producer stops making (retires)a certain variety, a stuffed animal of that variety will be worth $100; otherwise it is worth $0. There is 25% chance that any variety will be retired. For the purchase of an individual animal, what is the value to Sarah of knowing ahead of time whether or not that variety will be retired?

Question 36

Catherine is risk-averse. When faced with a choice between a gamble and a certain level of wealth she will

A)always prefer the gamble.
B)always prefer the certain level of wealth.
C)prefer the gamble if the expected utility from it is higher than the utility from the certain level of wealth.
D)prefer the certain level of wealth if the expected utility from the gamble is higher than the utility of the certain level of wealth.

Question 37

Variance is a measure of ________ and the lower the variance, ________.

A)expected profit; the lower the profit
B)risk; the lower the risk
C)standard deviation; lower the standard deviation
D)risk; the greater the risk

Question 38

A lottery game pays $500 with .001 probability and $0 otherwise. The variance of the payout is

A)15.8.
B)249.50.
C)249.75.
D)499.

Question 39

All else held constant, as the variance of a payoff increases, the

A)expected value of the payoff increases.
B)risk of the payoff increases.
C)expected value of the payoff decreases.
D)risk of the payoff decreases.

Question 40

Expected utility is

A)the maximum utility that a person can get from a set of possible outcomes.
B)the probability-weighted mean of the utility gained from a set of possible outcomes.
C)negative for risk-averse people.
D)indeterminant for risk preferring people.

Question 41

If a person is risk neutral, then she

A)is indifferent about taking a fair bet.
B)will pay a premium to avoid a fair bet.
C)has a horizontal utility function.
D)has zero marginal utility of wealth.

Question 42

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob's expected utility is

A)a.
B)b.
C)c.
D)d.

Question 43

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob is risk averse because

A)his utility function is convex.
B)he has negative marginal utility of wealth.
C)he is willing to pay a premium to avoid a risky situation.
D)All of the above.

Question 44

Someone who is risk-preferring has

A)diminishing marginal utility of wealth.
B)constant marginal utility of wealth.
C)increasing marginal utility of wealth.
D)less marginal utility of wealth than someone who is risk-preferring.

Question 45

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob's expected wealth is

A)$0.
B)$50.
C)$75.
D)$100.

Question 46

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob is risk averse because

A)his utility function is concave.
B)he has diminishing marginal utility of wealth.
C)he is willing to pay a premium to avoid a risky situation.
D)All of the above.

Question 47

Bob invests $25 in an investment that has a 50% chance of being worth $100 and a 50% chance of being worth $0. From this information we can conclude that Bob is

A)risk preferring.
B)risk neutral.
C)risk averse.
D)Any of the above.

Question 48

Bob invests $75 in an investment that has a 50% chance of being worth $100 and a 50% chance of being worth $0. From this information we can conclude that Bob is

A)risk preferring.
B)risk neutral.
C)risk averse.
D)irrational.

Question 49

Someone who is risk-neutral has

A)diminishing marginal utility of wealth.
B)constant marginal utility of wealth.
C)increasing marginal utility of wealth.
D)less marginal utility of wealth than someone who is risk-preferring.

Question 50

A risk-preferring person is willing to pay

A)a risk premium.
B)a fee to make a fair bet.
C)to obtain decreasing marginal utility.
D)None of the above.

Question 51

Natasha is going to buy a risky asset that has an expected value of $62, which yields an expected utility of 146. Her risk premium is $19. What is her certainty equivalent?

A)$19
B)$43
C)$81
D)$208

Question 52

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Living with this risk gives Bob the same expected utility as if there was no chance of theft and his wealth was

A)$0.
B)$20.
C)$30.
D)$50.

Question 53

A person who is risk-neutral will

A)pay a small risk premium when making a choice.
B)pick a slightly less risky option with a slightly lower expected value.
C)pick the option with the highest expected value.
D)None of the above.

Question 54

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. If Bob could keep $50 with certainty, his utility would be

A)a.
B)b.
C)c.
D)d.

Question 55

For a risk-neutral person, the expected utility associated with various levels of wealth

A)is above the person's utility function.
B)is below the person's utility function.
C)is equal to the person's utility function.
D)does not exist.

Question 56

Bob invests $50 in an investment that has a 50% chance of being worth $100 and a 50% chance of being worth $0. From this information we can conclude that Bob is NOT

A)risk preferring.
B)risk neutral.
C)risk averse.
D)rational.

Question 57

If a person is entertained by gambling, then

A)she is not risk averse.
B)she does not understand the concept of a fair game.
C)she may gamble even if it is an unfair game.
D)she will definitely not buy automobile insurance.

Question 58

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. The midpoint of the chord that runs from zero and intersects the utility function where wealth is 100, represents Bob's

A)risk premium.
B)expected utility of receiving $50 with certainty.
C)expected utility of receiving $0 50% of the time and $100 50% of the time.
D)risk neutrality.

Question 59

Natasha is going to buy a risky asset that has an expected value of $62, which yields an expected utility of 146. Equivalently, she could get utility of 146 from a certainty equivalent of $43. What is Natasha's risk premium?

A)$19
B)$43
C)$103
D)$105

Question 60

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. What is the most Bob would pay for insurance that would replace his $100 should it be stolen?

A)$30
B)$50
C)$70
D)$75

Question 61

The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob will buy theft insurance to cover the full $100

A)as long as it does not cost more than $25.
B)as long as it does not cost more than $50.
C)as long as it does not cost more than $70.
D)at any price.

Question 62

If two events are positively correlated but NOT perfectly correlated, then

A)diversification is not necessary since there is no risk.
B)diversification eliminates all risk.
C)diversification does not reduce risk at all.
D)diversification can reduce risk.

Question 63

If a person willingly plays an unfair game that is NOT in his favor, he is risk loving.

Question 64

If Stock A and Stock B both increase in value at the same time, they are

A)negatively correlated.
B)uncorrelated.
C)positively correlated.
D)certain bets.

Question 65

If Stock A increases in value when Stock B decreases in value at the same time, they are

A)negatively correlated.
B)uncorrelated.
C)positively correlated.
D)in different industries.

Question 66

A fair game is a game in which the chances are 50-50 that you win or lose.

Question 67

Buying a diversified mutual stock fund allows you to

A)completely avoid all types of risk.
B)avoid only random, unsystematic risk.
C)avoid only systematic risk.
D)avoid risk only when all the stock prices are perfectly correlated.

Question 68

If Stock A sometimes increases and sometimes decreases in value when Stock B increases in value at the same time, they are

A)negatively correlated.
B)uncorrelated.
C)positively correlated.
D)random bets.

Question 69

What type of risk behavior does the person exhibit who is willing to pay $5 for the chance to bet $60 on a game where 20% of the time the bet returns $100, and 80% of the time returns $50? Explain.

Question 70

The ability of diversification to reduce risk

A)is greater the more negatively correlated the two events are.
B)is greater the more positively correlated the two events are.
C)is greater the more uncorrelated the two events are.
D)is greater the more risk averse the individual is.

Question 71

Searching the Internet for information to help select a product that is more reliable is most likely to be done by a

A)risk-averse person.
B)risk-neutral person.
C)risk-preferring person.
D)This cannot be determined with the information provided.

Question 72

If Stock A and Stock B both decrease in value at the same time, they are

A)negatively correlated.
B)uncorrelated.
C)positively correlated.
D)bad bets.

Question 73

If two events are perfectly negatively correlated, then

A)diversification can reduce but not eliminate risk.
B)diversification can eliminate risk.
C)diversification has no impact on risk.
D)diversification cuts risk in half.

Question 74

A stock mutual fund is generally

A)less risky than buying individual stocks.
B)more risky than buying individual stocks.
C)just as risky as buying individual stocks.
D)a way for the rich to avoid taxes.

Question 75

In terms of the stock market, systematic risk refers to the fact that

A)some stocks have higher returns than others.
B)some stocks' returns have a higher variance than others.
C)all stock prices are correlated with the health of the economy.
D)most stock prices are perfectly negatively correlated.

Question 76

If a person is risk averse, then she has negative marginal utility of wealth.

Question 77

Making many risky bets

A)reduces your expected value.
B)is called risk-pooling and can reduce risk.
C)is irrational.
D)is called risk pooling and increases your expected value.

Question 78

If two events are perfectly positively correlated, then

A)diversification is not necessary since there is no risk.
B)diversification eliminates all risk.
C)diversification does not reduce risk at all.
D)diversification only cuts the risk in half.

Question 79

If Stock A sometimes increases and sometimes decreases in value when Stock B decreases in value at the same time, they are

A)negatively correlated.
B)uncorrelated.
C)positively correlated.
D)random bets.

Question 80

Taking actions that reduce risk

A)raise your expected value.
B)makes you less risk-averse.
C)are impractical in most circumstances.
D)change your utility function.