Question 1

Explain why a riskier asset offers a higher expected return.

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Question 2

Explain the rapid rise in popularity of mutual funds.

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Question 3

An individual owns a $100,000 home. She determines that her chances of suffering a fire in any given year to be 1/1000 (0.001). She correctly calculates her expected loss in any year to be
$100. Explain why this really isn't a good way to measure her potential for loss.

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Question 4

Calculate the expected value of an investment that has the following payoff frequency: a quarter of the time it will pay $2,000, half of the time it will pay $1,000 and the remaining time it will pay $0.

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Question 5

Briefly explain the difference between idiosyncratic risk and systematic risk. Provide an example of each.

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Question 6

Calculate the expected value, the expected return, the variance and the standard deviation of an asset that requires a $1000 investment, but will return $850 half of the time and $1,250 the other half of the time.

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Question 7

Explain why returns on assets compensate for systematic risk but not for idiosyncratic risk.

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Question 8

Explain the following: Risk results from the fact that more outcomes could happen than will happen.

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Question 9

What would be the impact of leverage on the expected return and standard deviation of purchasing an asset with 10% of the owner's funds and 90% borrowed funds?

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Question 10

What is the probability of tossing a pair of dice once and getting a 1? How about a 7?

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Question 11

Identify at least three possible sources for a risk an individual may face in planning for retirement.

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Question 12

You do some research and find for a driver of your age and gender the probability of having an accident that results in damage to your automobile exceeding $100 is 1/10 per year. Your auto insurance company will reduce your annual premium by $40 if you will increase your collision deductible from $100 to $250. Should you? Explain.

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Question 13

What would be the standard deviation for a $1,000 risk-free asset that returns $1,100?

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Question 14

What is the expected value of a $100 bet on a flip of a fair coin, where heads pays double and tails pays zero?

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Question 15

An individual faces two alternatives for an investment. Asset 'A' has the following probability of return schedule:
  
Asset 'B' has a certain return of 10.25%. If this individual selects asset 'A' does it imply she is risk averse? Explain.

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Question 16

You buy an asset for $2,500. The asset will return $3,300 half of the time and $2,700, the other half. The expected return is 20% (a gain of $500) and the standard deviation is 12% ($300). How would using $1,250 of borrowed funds change the expected return and standard deviation specifically?

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Question 17

Why isn't it correct to say that people who are risk averse avoid risk?

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Question 18

Explain why a company offering homeowners insurance policies would want to insure homes across a wide geographic area.

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Question 19

If there are 1,000 people, each of whom owns a $100,000 house, and they each stand a
1/1,000 chance each year of suffering a fire that will totally destroy their house, what is the minimum that they would have to pay annually for fire insurance?

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Question 20

Consider the following two assets with probability of return = Pi and return = Ri. Calculate the expected return for each and the standard deviation. Which one carries the greatest risk? Why?

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Quiz 5: Understanding Risk