Deck 5: Uncertainty and Information

Question 1

More risk averse people will

A)hold fewer risky assets because marginal utility is rapidly diminishing.
B)hold fewer risky assets because marginal utility is greater.
C)hold fewer risky assets because rates of return are more uncertain.
D)hold fewer risky assets because marginal utility is negative.

Answer 1

A

Question 2

The option to delay the choice of portfolio allocation is valuable because

A)interest costs are positive.
B)volatility of returns is lower.
C)more can be placed into high return,risky assets.
D)the allocation can be based on new information.

Answer 2

D

Question 3

An individual will never buy complete insurance if

A)he or she is risk averse.
B)insurance premiums are unfair.
C)he or she is a risk taker.
D)insurance premiums are fair.

Answer 3

C

Question 4

Expected value is defined as

A)the profit on a fair bet.
B)the most likely outcome of a given experiment.
C)the outcome that will occur on average for a given experiment.
D)the relative frequency with which an event will occur.

Question 5

An option may add value to a transaction because:

A)interest charges are reduced.
B)the price of the good is reduced.
C)additional information may become available.
D)options provide buyers with monopsony power.

Question 6

Which of the following utility functions would indicate the most (relative)risk averse behavior?

A)U(W)= W.
B)U(W)= .
C)U(W)= ln W.
D)U(W)= 1/W.

Question 7

The condition for optimal portfolio choice can be represented by:

A) .
B) .
C) .
D) .

Question 8

A risk averse individual is offered a gamble that promises a gain of $1000 with probability 0 .25 and a loss of $300 with probability 0.75 .Given this situation,he or she will

A)definitely take the gamble.
B)definitely not take the gamble.
C)definitely take the gamble if his or her income is high enough.
D)take an action that cannot be determined given the information available.

Question 9

If a fair game is played many times the monetary losses or gains will

A)approach zero.
B)be negative.
C)be positive.
D)result in an outcome that cannot be determined without more information.

Question 10

Risk-averse individuals will diversify their investments because this will

A)increase their expected returns.
B)provide them with some much-needed variety.
C)reduce the variability of their returns.
D)reduce their transactions costs.

Question 11

Which of the following utility functions exhibits constant relative risk aversion?

A)U(W)= W.
B)
C)U(W)= ln W.
D)U(W)= .

Question 12

Suppose a person's utility of wealth is given by and his or her initial wealth is 10,000.What is the maximum amount he or she would pay for insurance against a 50 percent chance of losing 3,600?

A)1,800.
B)1,900.
C)2,000.
D)2,100.

Question 13

Risk aversion is best explained by

A)timidness.
B)increasing marginal utility of wealth.
C)constant marginal utility of wealth.
D)decreasing marginal utility of wealth.

Question 14

People who always choose not to participate in fair games are called

A)risk takers.
B)risk averse.
C)risk neutral.
D)broke.

Question 15

An individual whose utility function is given by (where W_i is wealth in state i)will

A)never gamble no matter how favorable the odds.
B)only gamble if the expected value of the bet is positive.
C)gamble if the bet is not too unfair.
D)always gamble,no matter how unfavorable the odds.

Question 16

Which of the following utility functions exhibits constant absolute risk aversion?

A)U(W)= W.
B)
C)U(W)= ln W.
D)U(W)= .