Deck 11: Choices Involving Risk

Question 1

Risk

A) Is inherent in every action or decision
B) Exists whenever the consequences of a decision are uncertain
C) Exists when outcomes are certain
D) Is a good that can be purchased

Answer 1

Exists whenever the consequences of a decision are uncertain

Question 2

Suppose Lily's indifference curves are defined as where C is a constant.Lily receives 64 units of food when it is sunny,F_S and 16 units of food when there is a hurricane,F_H.If the probability of sunshine is P = 0.75,the expected consumption is

A) 52
B) 28
C) 40
D) 5

Answer 2

28

Question 3

Refer to Figure a.If decreases,the x-intercept for the constant expected consumption line

A) Increases
B) Decreases
C) Does not change
D) Cannot be determined without more information

Answer 3

Increases

Question 4

A person is risk averse if

A) His consumption bundle lies at the tangency of the indifference curve and the constant expected consumption line
B) He views variability as a bad thing
C) For a given level of expected consumption, he prefers the risk less bundle to the risky one
D) All of the above

Question 5

Refer to Figure b.Suppose consumers choose to consume food in two different states,sunny weather,F_S and during a hurricane,F_H.As the consumer moves from point A to B along the indifference curve,the variability of consumption

A) Decreases
B) Increases
C) Remains constant
D) Increases for one good, but decreases for the other

Question 6

What is the certainty equivalent of the bundle described in problem 18?

A) 3
B) 5
C) 25
D) 49

Question 7

What is the expected payoff of an investment that yields $1,000,000 with a probability of 0.001 and $0 with a probability of 0.999?

A) $1,000,000
B) $1,000
C) $10,000
D) $500,000

Question 8

Given the information in problem 2 above,the probability that the Giants lose and it snows is

A) 21%
B) 26%
C) 95%
D) 25%

Question 9

What is the standard deviation of the investment payoff described in problem 4?

A) $0
B) $2,581,875
C) $42.50
D) $1,606.82

Question 10

What is the standard deviation of the investment payoff described in problem 6?

A) $999000
B) $1000
C) $999,000,000
D) $31,607

Question 11

Refer to Figures d and e.Bundle A is preferred to bundle B in Figure e and not figure d because

A) The MRS between water in a rainy season and during a drought is higher in e than in d
B) As the probability of a drought increases, consumers are no longer indifferent between the two bundles
C) As the probability of a drought decreases, water in a rainy season becomes less valuable
D) Consumers are indifferent between bundles A and B as the probability of a drought increases

Question 12

What is the risk premium of the bundle described in problem 18?

A) 5
B) 12
C) 16
D) 3

Question 13

What is the risk premium for the bundle described in problem 15?

A) 52
B) 24
C) 49
D) 3

Question 14

Refer to Figures b and c.In the figures above,the probability of sunny weather,P,is higher in

A) Figure b
B) Figure c
C) P does not influence the slope of the indifference curve
D) Bundle A versus C in either figure

Question 15

Refer to Figures d and e.Water is crucial for survival,but it is particularly valuable during a drought when water is scarce.The probability of a drought is (1-P),W_D represents the quantity of water in a drought,while W_R represents the quantity of water in a rainy season.Which set of indifference curves above best represent a relatively high probability of a drought?

A) Figure d
B) Figure e
C) Probabilities do not influence indifference curves
D) Neither

Question 16

What is the expected payoff of an investment that yields $5,000 with a probability of 0.15 and $500 with a probability of 0.85?

A) $325
B) $5,500
C) $1,175
D) $2,750

Question 17

Refer to Figure a.Assuming the bold line in the graph above is a constant expected consumption line where ,which constant expected consumption line reflects an increase in ?

A) Dotted line
B) Dashed line
C) An increase in
does not result in an change in the expected consumption line
D) A change in
results in a parallel shift in the expected consumption line, so neither the red or green line reflects this change

Question 18

What is the certainty equivalent of the bundle described in problem 15?

A) 49
B) 52
C) 7
D) 25

Question 19

Suppose Alice is deciding whether or not to go to a New York Giants game.Alice's enjoyment and thus decision,depends upon two uncertain events that are out of her control: whether the Giants win and whether it snows.She will be happiest if the Giants win and it does not snow.The newspaper reports a 35% chance for snow and the Giants record suggests a 40% chance of winning.The probability that the Giants win and that it does not snow is

A) 75%
B) 5%
C) 26%
D) 35%

Question 20

Suppose Brandon's indifference curves are defined as ,where C is a constant,F_S is consumption during sunny weather and F_H is consumption during a hurricane.Further suppose Brandon receives 64 units of food when it is sunny and 16 units when there is a hurricane.If the probability of sunshine is P = 0.75,expected food consumption is

A) 28
B) 40
C) 52
D) 80

Question 21

Assume Brandon's benefit function for water is and he consumes water both in droughts,W_D and in the rainy season,W_R.Assume his water bundle is W_D = 400 and W_R = 100 and the probability of drought is 0.75.Expected water consumption is

A) 500
B) 250
C) 325
D) 175

Question 22

Refer to Figure g.Lily's benefit function (dashed)is more concave than Millie's benefit function (dotted).Lily

A) Is more risk averse than Millie
B) Is less risk averse than Millie
C) Has a smaller risk premium than Millie
D) Has a larger certainty equivalent than Millie

Question 23

Refer to Figure f.A benefit function,W(F),is plotted in Figure f.Point A represents the

A) Risk premium of the consumption bundle
B) Expected utility of the consumption bundle
C) Certainty equivalent of the consumption bundle
D) Expected consumption

Question 24

Refer to Figure f.A benefit function is plotted in Figure f.Point D represents the

A) Risk premium of the consumption bundle
B) Expected utility of the consumption bundle
C) Certainty equivalent of the consumption bundle
D) Expected consumption

Question 25

Brandon's certainty equivalent given the information in problem 29 is

A) 45.75
B) 33.06
C) 30.5
D) 61

Question 26

An insurance policy is

A) The contract that reduces the financial loss associated with some risky event
B) The amount of money a policy holder pays for the insurance policy
C) The amount of money a policy holder receives if a specific loss occurs
D) The probability of loss from a specific event

Question 27

Brandon's risk premium given the information in problem 25 is

A) 250
B) 325
C) 17.5
D) 18.75

Question 28

What is Brandon's expected utility given the information in problem 25?

A) 10
B) 17.5
C) 20
D) 30

Question 29

Brandon's risk premium given the information in problem 29 is

A) 66.31
B) 0.19
C) 33.16
D) 3.20

Question 30

Refer to Figure g.Lily's benefit function (dashed)is more concave than Millie's (dotted)in Figure g.Millie

A) Is more risk averse than Lily
B) Is less risk averse than Lily
C) Has a larger risk premium than Lily
D) Has a lower certainty equivalent than Lily

Question 31

A person is risk neutral if

A) Her indifference curve is concave to the origin
B) Her indifference curve is convex to the origin
C) Her indifference curve coincides with the expected consumption line
D) Her indifference curve coincides with guaranteed consumption line

Question 32

What is Brandon's expected utility given the information in problem 29?

A) 5.75
B) 33.25
C) 11
D) 30.5

Question 33

Brandon's certainty equivalent given the information in problem 25 is

A) 250
B) 306.25
C) 18.75
D) 17.5

Question 34

Refer to Figure f.A benefit function is plotted in Figure f.The distance C represents the

A) Risk premium of the consumption bundle
B) Expected utility of the consumption bundle
C) Certainty equivalent of the consumption bundle
D) Expected consumption

Question 35

Suppose we can represent Brandon's preferences for water with an expected utility function, ,where W_D represents a quantity of water during a drought and W_R represents a quantity of water in a rainy season.Brandon is

A) Risk averse
B) Risk neutral
C) Risk loving
D) None of the above

Question 36

Assume Brandon's benefit function for water is and he consumes water both in droughts,W_D and in the rainy season,W_R.Assume his water bundle is W_D = 36 and W_R = 25 and the probability of drought is 0.75.Expected water consumption is

A) 33.25
B) 61
C) 30.5
D) 27

Question 37

A person is risk loving if

A) For a given level of expected consumption, he prefers a risky bundle to a risk less one
B) His indifference curve is convex to the origin
C) His indifference curve is concave to the origin
D) A and C

Question 38

An insurance benefit is

A) The contract that reduces the financial loss associated with some risky event
B) The amount of money a policy holder pays for the insurance policy
C) The amount of money a policy holder receives if a specific loss occurs
D) The probability of loss from a specific event

Question 39

Refer to Figure f.A benefit function is plotted in Figure f.Point B represents the

A) Risk premium of the consumption bundle
B) Expected utility of the consumption bundle
C) Certainty equivalent of the consumption bundle
D) Expected consumption

Question 40

Suppose Brandon's benefit function for water is Brandon is

A) Risk averse
B) Risk neutral
C) Risk loving
D) None of the above

Question 41

Two variables are uncorrelated if

A) They move in the same direction
B) They move in the opposite direction
C) Their movements tend to be unrelated
D) One is simply a multiple of the other

Question 42

If two investments are perfectly negatively correlated

A) Diversification is not effective at reducing risk
B) Bets are perfectly hedged and risks are canceled out
C) Diversification reduces risk without changing the expected payoff
D) Diversification reduces both risk and the expected payoff

Question 43

Which investment described in problem 48 is best for Dean?

A) Invest only in Pretty Kitty Grooming
B) Invest only in Dog Gone Salon
C) Invest in both Pretty Kitty Grooming and Dog Gone Salon
D) Invest in neither

Question 44

Suppose Dean has $500 and he wants to maximize his expected benefit, ,where X is his resources in dollars.There are two companies he could invest in: Dog Gone Salon,which has a payoff of $1,000 with 50% probability and $0 with 50% probability and Pretty Kitty Grooming,which has a payoff of $2,000 with 50% probability and $0 with 50% probability.Dean's expected payoff from investing in Dog Gone Salon only is

A) $1,000
B) $500
C) $0
D) $1,500

Question 45

Two variables are positively correlated if

A) They move in the same direction
B) They move in the opposite direction
C) Their movements tend to be unrelated
D) One is simply a multiple of the other

Question 46

Two variables are negatively correlated if

A) They move in the same direction
B) They move in the opposite direction
C) Their movements tend to be unrelated
D) One is simply a multiple of the other

Question 47

If two investments are uncorrelated

A) There is no benefit from diversification
B) There is no benefit to hedging
C) Diversification reduces risk without changing the expected payoff
D) Diversification reduces both risk and the expected payoff

Question 48

If two investments are perfectly positively correlated

A) There is no benefit from diversification
B) Bets are perfectly hedged and risks are canceled out
C) Diversification reduces risk without changing the expected payoff
D) Diversification reduces both risk and the expected payoff

Question 49

Explain why a risk averse individual will purchase full insure if a policy is actually fair,but only partially insure or not insure at all,if it is not.

Question 50

Dean's expected payoff from investing $250 in both Dog Gone Salon and Pretty Kitty Grooming is

A) $62.50
B) $500
C) $750
D) $250

Question 51

Explain the relationship between the correlation of payoffs and the risk reducing effects of diversification and hedging.

Question 52

Dean's expected payoff from investing in Pretty Kitty Grooming only based upon the information given in problem 48 is

A) $500
B) $2,000
C) $1,000
D) $1,500

Question 53

An insurance premium is

A) The contract that reduces the financial loss associated with some risky event
B) The amount of money a policy holder pays for the insurance policy
C) The amount of money a policy holder receives if a specific loss occurs
D) The probability of loss from a specific event