Question 1

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.

Accepted Answer

Systematic risk refers to the risk inherent to the entire market or an entire market segment. It is also known as market risk, and it cannot be diversified away through portfolio management. The health of the economy affects the performance of all stocks, making them correlated and subject to systematic risk. Options A, B, and D refer to unsystematic risk, which can be diversified away through proper portfolio management.

Question 2

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.

Accepted Answer

The answer of What type of risk behavior does the...

Question 3

Farmers who purchase insurance against crop failures tend to be pooled with farmers far away.Why might this be the case?
A) The weather in a single geographic area represents idiosyncratic risk, which is diversifiable.
B) The weather in a single geographic area represents systematic risk, which is not diversifiable.
C) The weather in far-flung geographic areas represents systematic risk, which is not diversifiable.
D) The weather in far-flung geographic areas are commonly positively correlated.

Accepted Answer

Pooling farmers from different geographic areas helps in diversifying idiosyncratic risks, such as localized weather patterns, which can vary significantly from one area to another. This diversification reduces the overall risk for insurers.

Question 4

Which of the following losses to an individual would an insurance company NOT cover?
A) The person's automobile is stolen.
B) Fire destroys the person's home.
C) The person's father dies.
D) The person's country is invaded.

Accepted Answer

Losses resulting from a war or invasion are typically excluded from insurance coverage.

Question 5

After Hurricane Katrina,there was considerable public outrage that many of the properties were not insured against flooding although they were insured against wind damage.What might explain these different approaches to insurance?
A) The risk of wind damage is potentially diversifiable, but the risk of flooding is not.
B) The risk of flood damage is potentially diversifiable, but the risk of wind damage is not.
C) predatory insurance policies
D) Neither the risk of wind damage nor the risk of flooding is diversifiable.

Accepted Answer

Wind damage is a risk that can potentially be diversified through geographic diversification, i.e., insuring properties across a broad geographic area to mitigate losses from a single event. On the other hand, flooding is a risk that is not easily diversified, as it is often caused by a widespread event affecting a large area. As a result, flood insurance tends to be more expensive and less widely purchased.

Question 6

If fair insurance is offered to a risk-averse person,she will
A) buy enough insurance to eliminate all risk.
B) not buy any insurance because it is overpriced.
C) not buy any insurance since the marginal utility of the amount of the payment is positive.
D) buy enough insurance to cover about half of the possible loss.

Accepted Answer

A risk-averse person prefers to eliminate uncertainty when possible, and fair insurance allows them to do so by covering potential losses, thus they will buy enough insurance to eliminate all risk.

Question 7

If global warming began to cause random world-wide damage to crops,insurance companies
A) would insure against specific crop failures.
B) would not insure against specific crop failures.
C) would be indifferent between insuring or not.
D) would find themselves facing prosecution for ignoring the problem for so long.

Accepted Answer

Insurance companies typically avoid insuring against widespread and highly correlated risks because it's difficult to diversify these risks and manage potential losses. Random worldwide damage to crops due to global warming represents such a risk, making it unlikely that insurers would offer coverage for specific crop failures.

Question 8

Describe how the risk premium for a person with a convex utility function is determined.

Accepted Answer

The answer of Describe how the risk premium for a...

Question 9

-Bob's utility function is shown in the above figure.He currently has $100 worth of property,but there is a 50% chance that all of it will be stolen.An insurance company offers to reimburse Bob for his loss if the money is stolen.What is the most that Bob would pay for such a policy? Explain.

Accepted Answer

The answer of 
-Bob's utility function is shown in the...

Question 10

A person is betting a coin will come up heads or tails.The coin always lands on one of these two outcomes.This person can bet to
A) eliminate only the systematic risk.
B) eliminate only the random risk.
C) eliminate all risk.
D) All of the above.

Accepted Answer

In a fair coin toss, there is always a 50% chance of either heads or tails, meaning there is inherent randomness and no systematic risk to eliminate. Therefore, it is impossible to eliminate all risk in this scenario.

Question 11

Many people do not fully insure against risk because
A) they are risk averse.
B) the insurance companies are all crooks.
C) the insurance offered is less than fair.
D) the insurance offered is more than fair.

Accepted Answer

Insurance is often perceived as less than fair because the premiums paid over time can exceed the expected losses, making individuals reluctant to fully insure against risk.

Question 12

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.

Accepted Answer

A stock mutual fund is generally less risky than buying individual stocks because it is diversified. This means that it holds a variety of stocks, reducing the impact of any one stock performing poorly. Additionally, experienced fund managers often manage the stocks within the fund, which can further reduce risk.

Question 13

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.

Accepted Answer

Perfectly positively correlated events move in the same direction and have a correlation coefficient of +1. Diversification aims to reduce risk by investing in different assets that are not perfectly correlated with each other. If two events are perfectly positively correlated, diversification will not reduce risk at all.

Question 14

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.

Accepted Answer

A risk-averse person is someone who prefers to avoid risks and uncertainty. Searching the internet for information to help select a more reliable product is a way to reduce the risk of purchasing a faulty or unreliable product, which is consistent with the behavior of a risk-averse person.

Question 15

Insurance companies do NOT cover losses that would
A) happen to all of the policyholders at once.
B) happen with a very low probability.
C) happen to just a handful of policyholders.
D) happen with uncertainty.

Accepted Answer

Insurance companies typically do not cover events that would affect all of the policyholders at once because such events are not insurable risks due to their inability to spread the risk among a large pool of policyholders.

Question 16

A stock mutual fund's primary advantage is to allow
A) investors to diversify away systematic risk.
B) investors to diversify away all risk.
C) investors to diversify away idiosyncratic risk.
D) the rich to avoid taxes.

Accepted Answer

Mutual funds allow investors to diversify away idiosyncratic risk (also known as unsystematic risk) by investing in a variety of stocks, thereby reducing the impact of any single stock's performance on the overall portfolio.

Question 17

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.

Accepted Answer

Buying a diversified mutual stock fund does not completely eliminate all types of risk, including systematic risk (such as market fluctuations or economic conditions). However, by investing in a range of stocks within the fund, investors can avoid some of the random, unsystematic risk associated with individual stocks. Therefore, the best choice would be B, avoiding only random, unsystematic risk.

Question 18

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.

Accepted Answer

Diversification reduces risk most effectively when the events or assets are negatively correlated, as losses in one can be offset by gains in the other.

Question 19

Steven currently has wealth of $10,000.He is risk averse about losing any of his wealth,but risk loving about adding to his wealth.Draw his utility function.

Accepted Answer

The answer of Steven currently has wealth of $10,000.He is...

Question 20

Which of the following helps to reduce risk?
A) Abstain from risk taking.
B) Obtain more information.
C) Diversify.
D) All of the above.

Accepted Answer

All of the above options help to reduce risk. Abstaining from risk-taking completely eliminates the possibility of loss but also limits potential gains. Obtaining more information can help one make more informed decisions and reduce uncertainty. Diversification, spreading investments across different types of assets or investments, can reduce overall portfolio risk. Therefore, all three options are important in risk management.

Quiz 17: Uncertainty

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

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.

Farmers who purchase insurance against crop failures tend to be pooled with farmers far away.Why might this be the case?

Which of the following losses to an individual would an insurance company NOT cover?

After Hurricane Katrina,there was considerable public outrage that many of the properties were not insured against flooding although they were insured against wind damage.What might explain these different approaches to insurance?

If fair insurance is offered to a risk-averse person,she will

If global warming began to cause random world-wide damage to crops,insurance companies

Describe how the risk premium for a person with a convex utility function is determined.

-Bob's utility function is shown in the above figure.He currently has $100 worth of property,but there is a 50% chance that all of it will be stolen.An insurance company offers to reimburse Bob for his loss if the money is stolen.What is the most that Bob would pay for such a policy? Explain.

A person is betting a coin will come up heads or tails.The coin always lands on one of these two outcomes.This person can bet to

Many people do not fully insure against risk because

A stock mutual fund is generally

If two events are perfectly positively correlated,then

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

Insurance companies do NOT cover losses that would

A stock mutual fund's primary advantage is to allow

Buying a diversified mutual stock fund allows you to

The ability of diversification to reduce risk

Steven currently has wealth of $10,000.He is risk averse about losing any of his wealth,but risk loving about adding to his wealth.Draw his utility function.

Which of the following helps to reduce risk?