Question 1

Many people do not fully insure against risk because

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 2

Buying a diversified mutual stock fund allows you to

Accepted Answer

Buying a diversified mutual stock fund helps in avoiding random, unsystematic risk, which is the risk that a particular stock or industry faces due to factors specific to it, such as management changes or product failures. However, systematic risk cannot be eliminated as it is the risk inherent in the entire market or economy, and is beyond an individual company's control. Therefore, option B is the best choice. Options A, C, and D are incorrect as they either suggest complete avoidance of all risks or assume an unrealistic scenario of perfect correlation between stock prices.

Question 3

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

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 4

Which of the following helps to reduce risk?

Accepted Answer

All of the above options help to reduce risk. Abstaining from risk taking altogether eliminates the possibility of negative outcomes, obtaining more information provides more knowledge and understanding to make informed decisions, and diversifying spreads risk across multiple options or investments.

Question 5

A stock mutual fund's primary advantage is to allow

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 6

Suppose a blackjack gambler approaches an insurance company and seeks to purchase an insurance policy that his next trip to Reno,NV will not net $10,000.The insurance company

Accepted Answer

The proposed event of the gambler's net winnings in Reno being $10,000 or not is an example of uncertainty, not risk. Risk involves situations where the probability of an event occurring can be estimated, such as the likelihood of flipping heads or tails with a fair coin. In the case of the gambler's net winnings, it is impossible to estimate the probability with any degree of accuracy, making it an uncertain event. Insurance companies only provide coverage for events that involve risk, not uncertainty, so they would not sell the gambler an insurance policy in this scenario.

Question 7

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

Accepted Answer

Systematic risk refers to the risk inherent in the entire market or economy, rather than specific to an individual stock. This means that all stocks are affected by the health of the economy and are subject to the same macroeconomic events, such as inflation or recession. Therefore, option C is correct as it indicates that all stock prices are correlated with the health of the economy, reflecting a systematic risk. Options A, B, and D refer to specific risks associated with individual stocks and are therefore not relevant to systematic risk.

Question 8

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

Accepted Answer

Insurance policies typically do not cover losses due to war or acts of foreign enemies, which would include the scenario of a person's country being invaded.

Question 9

What is one reason the federal government might "bail out" farmers in flood prone areas of the country?

Accepted Answer

Flooding in certain areas is not diversifiable, meaning that there is no way to spread the risk around among many people or entities. Therefore, it may be necessary for the federal government to step in and provide financial assistance to farmers who are affected by these floods.

Question 10

A stock mutual fund is generally

Accepted Answer

A stock mutual fund is a collection of stocks from various companies, which spreads out the risk among the investors. This diversification helps to reduce the overall risk compared to holding a single stock. Therefore, option A is the correct answer. Option B is incorrect because holding individual stocks is riskier than holding a diversified portfolio of stocks. Option C is incorrect because mutual funds are less risky than holding individual stocks, as discussed above. Option D is incorrect because investing in mutual funds does not help anyone avoid taxes.

Question 11

Suppose a senior college football player approaches an insurance company and seeks to purchase an insurance policy against him receiving a career-ending injury.The insurance company

Accepted Answer

The proposal entails risk, not uncertainty, because the probability of a career-ending injury can be estimated based on historical data and actuarial analysis. This makes it insurable.

Question 12

One reason health insurance is very expensive is because

Accepted Answer

The answer of One reason health insurance is very expensive...

Question 13

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?

Accepted Answer

The risk of wind damage is potentially diversifiable, meaning that it is possible to spread the risk across different locations or properties. However, the risk of flooding is not diversifiable because it affects a larger geographical area and can cause widespread damage. Therefore, insurance companies may be less willing to insure against flooding, as it poses a higher potential risk.

Question 14

Suppose a patent applicant approaches an insurance company and seeks to purchase an insurance policy that her patent will not net $1m in the next three years.The insurance company

Accepted Answer

Uncertainty means there is no way to determine the probability of an event occurrence, whereas risk represents the known probability of an event occurrence. The insurance company can offer insurance policies for risks, not uncertainties. In this case, there is no way to determine if the patent will net $1m in the next three years, making it uncertain. Therefore, the insurance company will not sell an insurance policy for this proposal.

Question 15

The ability of diversification to reduce risk

Accepted Answer

The answer of The ability of diversification to reduce risk
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Question 16

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

Accepted Answer

The answer of A person is betting a coin will...

Question 17

Insurance companies do not cover losses that would

Accepted Answer

Insurance companies avoid covering losses that would happen to all policyholders at once, as it would be financially unsustainable.

Question 18

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

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 19

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

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 20

If two events are perfectly positively correlated,then

Accepted Answer

Perfectly positive correlation means that the two events move in complete sync with each other. Diversification is effective in reducing risk when there is non-perfect correlation between events. However, in a perfectly positively correlated scenario, diversification will not reduce risk at all.

Quiz 17: Uncertainty