Question 1

Scenario: Buying Shares Jordi is considering buying shares in two companies, Apple and Microsoft.If he invests
$1,000 in Apple, there is a 40% probability that his investment will be worth only $800 and a 60% probability that it will be worth $1,200 at the end of one year.If he invests $500 in Apple, there is a 40% probability that his investment will be worth $400 and a 60% probability that it will be worth $600 at the end of the year.The corresponding numbers for investment in Microsoft are identical.
(Scenario: Buying Shares) Based on the information provided in the scenario Buying Shares, the probability that Jordi will sustain a loss is if he invests $1,000 in either Apple or Microsoft and is
________ if he invests $500 apiece in Apple and in Microsoft.

Accepted Answer

If Jordi invests $1,000 in either Apple or Microsoft, there is a 40% probability that he will sustain a loss. This means there is 60% probability that his investment will not result in a loss.

If Jordi invests $500 apiece in both Apple and Microsoft, the probabilities of sustaining a loss are independent of each other. Therefore, the probability of sustaining a loss in both investments is the product of the probabilities which is 0.4*0.4= 0.16 or 16%. Therefore, the probability that he will not sustain a loss in both investments is 1-0.16=0.84 or 84%. Thus, investing $500 each in Apple and Microsoft is the better choice as it reduces the overall risk.

Question 2

Barcelona and Los Angeles are similar towns, except Barcelona has a good public transportation system and Los Angeles does not.Auto insurance will probably be more expensive in ________, since the insurance _.

Accepted Answer

Since Los Angeles does not have a good public transportation system, more people are likely to own cars and therefore demand for auto insurance is likely to be higher.

Question 3

If those who are most willing to bear risk end up bearing it, then we say that the insurance market is:

Accepted Answer

The insurance market is efficient when those who are most willing to bear risk end up bearing it. This ensures that premiums are set according to risk and that resources are allocated efficiently.

Question 4

The funds that an insurance company could potentially pay out are known as the:

Accepted Answer

The funds that an insurance company could potentially pay out are known as the capital at risk, which reflects the amount of potential losses an insurer is exposed to. The other choices (fair premium, total premium, deductible) do not accurately describe the potential payment of funds by an insurance company.

Question 5

As the premium for an insurance policy falls, there is a(n):

Accepted Answer

The answer of As the premium for an insurance policy...

Question 6

Suppose the wealth of buyers in the insurance market falls.We would expect insurance premiums to ________ as the _.

Accepted Answer

The answer of Suppose the wealth of buyers in the...

Question 7

The strategy of eliminating (or almost eliminating) risks by taking a small share in many independent events or by taking advantage of the predictability associated with large numbers of independent events is known as:

Accepted Answer

This strategy is known as "pooling", which involves spreading risks by combining many independent risks into a single portfolio. This reduces the impact of any single event and increases predictability. Floating is not a commonly used term in risk management, specializing refers to focusing on a specific area of expertise, and screening involves identifying and selecting clients or projects with the lowest level of risk.

Question 8

An efficient market for risk (such as an insurance market) is most likely to exist:

Accepted Answer

An efficient market for risk is more likely to exist when there are significant differences in individuals' wealth levels and attitudes toward risk, as this diversity allows for the pooling and sharing of risk, which is the essence of insurance markets.

Question 9

The total amount of funds that potentially could be paid out by an insurance company is:

Accepted Answer

The answer of The total amount of funds that potentially...

Question 10

Suppose the probability of a major theft at a hotel is 1%, while the probability of an earthquake hitting the hotel is 2.3%.The probability that both would occur on the same day is therefore:

Accepted Answer

The answer of Suppose the probability of a major theft...

Question 11

Assume that flood insurance premiums are determined in the competitive market.Suppose that devastating floods along the Mississippi River have increased the degree of risk aversion among the insurance investors in this market.What will happen to the market for flood insurance policies?

Accepted Answer

An increase in risk aversion among insurance investors means that they are now less willing to supply flood insurance policies. This results in a leftward shift in the supply curve, causing equilibrium premiums to increase and quantity of insurance bought and sold to decrease. Therefore, choice C is the correct answer.

Question 12

Which of the following is one of the principles on which the insurance industry rests?

Accepted Answer

The principle that "Trade in risk can produce mutual gains" is one of the foundational principles on which the insurance industry is built. This concept of risk transfer allows for individuals and businesses to transfer financial risk to insurance companies, which then pool and spread the risk among their policyholders, resulting in a mutual benefit for all involved. The insurance industry also operates on other principles, such as the law of large numbers, underwriting, and rating.

Question 13

Which of the following is true if the insurance market is efficient?

Accepted Answer

An efficient insurance market transfers risk from those who are most risk-averse and want to get rid of it to those who are least bothered by the risk, such as insurers who are willing to take on risk in exchange for premiums. This results in a more efficient allocation of risk in the economy. Deductibles may help to reduce moral hazard, but they do not necessarily make the insurance market more efficient. Similarly, it is not necessarily true that society as a whole engages in less risky behavior in an efficient insurance market. Finally, premiums are determined by a number of factors, including the level of risk and the cost of providing coverage, and may not always be at the level of a "fair" insurance policy.

Question 14

As the premium for an insurance policy rises, there is a(n):

Accepted Answer

As the premium for an insurance policy rises, there is a decrease in the quantity demanded of insurance. This is because higher premiums make insurance less affordable for consumers, causing them to either reduce the coverage they purchase or opt not to purchase insurance at all. This does not affect the supply of insurance available in the market.

Question 15

Which of the following might explain why the supply curve of insurance policies would shift to the right?

Accepted Answer

The answer of Which of the following might explain why...

Question 16

People who want to reduce the risk they face may pay other people who are less sensitive to risk to take on some of their risk.As a result:

Accepted Answer

Trade in risk allows people who are more risk-averse to transfer their risk to those who are more willing to accept it. This can lead to a more efficient allocation of risk and a reduction in overall risk. Therefore, D is the correct answer. A is incorrect because trade in risk is not illegal. B is incorrect because trade in risk can actually increase mutual gains. C is incorrect because trade in risk does not necessarily lead to an increase in total risk. When people who are less sensitive to risk are willing to take on someone else's risk, it allows those who are more sensitive to risk to reduce their overall risk. This creates a market for risk and those who are willing to accept more risk will purchase from those who are less willing. Therefore, option D is the correct choice.

Question 17

We would consider a tornado and a CEO scandal that hit a construction company on the same day as:

Accepted Answer

Independent events are those whose outcomes do not affect each other. A tornado and a CEO scandal are unrelated occurrences, so they are independent events.

Question 18

On any particular day, the probability that it will rain is 25% and that you will be sick is 10%.The probability that both happen on the same day is:

Accepted Answer

The probability of both events happening can be found by multiplying the individual probabilities: 
0.25 * 0.1 = 0.025 or 2.5%. Therefore, the answer is choice C).

Question 19

Which of the following events are not independent?

Accepted Answer

The answer of Which of the following events are not...

Question 20

Scenario: Buying Shares Jordi is considering buying shares in two companies, Apple and Microsoft.If he invests
$1,000 in Apple, there is a 40% probability that his investment will be worth only $800 and a 60% probability that it will be worth $1,200 at the end of one year.If he invests $500 in Apple, there is a 40% probability that his investment will be worth $400 and a 60% probability that it will be worth $600 at the end of the year.The corresponding numbers for investment in Microsoft are identical.
(Scenario: Buying Shares) Based on the information provided in the scenario Buying Shares, which of the following is true?

Accepted Answer

The answer of Scenario: Buying Shares Jordi is considering buying...

Quiz 20: Uncertainty, Risk, and Private Information