ECO 2013: CHAPTER 14

There are many concerns for risk-averse lenders. Consider the following: 1. Lenders are concerned that borrowers with the greatest risk are the ones most likely to actively pursue loans. 2. Lenders are concerned that real GDP will decline leading to reduced corporate profits. 3. Lenders are concerned that products produced by certain corporations will become obsolete.

b. 2 is market risk; 3 is firm-specific risk

The fact that we observe a trade-off between risk and return is puzzling to economists, because that observation conflicts with the notion that most people are risk averse.

b. False

Veronica deposited $1,000 into an account two years ago. The first year she earned 7 percent interest; the second year she earned 5 percent. How much money does Veronica have in her account today?

c. $1,123.50

Suppose you put $350 into a bank account today. Interest is paid annually and the annual interest rate is 6 percent. The future value of the $350 after 4 years is

c. $441.87.

Dobson Construction has an investment project that would cost $150,000 today and yield a one-time payoff of $167,000 in three years. Among the following interest rates, which is the highest one at which Dobson would find this project profitable?

c. 3 percent

Which of the following is correct?

c. The larger the percentage of stock in a portfolio, the greater the risk, but the greater the average return.

A measure of the volatility of a variable is its

d. standard deviation.

Anna deposited $10,000 into an account three years ago. The first year she earned 12 percent interest, the second year she earned 8 percent interest, and the third year she earned 4 percent interest. How much money does she have in her account today?

a. $12,579.84

You could borrow $2,000 today from Bank A and repay the loan, with interest, by paying Bank A $2,154 one year from today. Or, you could borrow X dollars today from Bank B and repay the loan, with interest, by paying Bank B $2,477.10 one year from today. In order for the same interest rate to apply to the two loans, X =

a. $2,300.00.

Missy recently rearranged her portfolio so that it has a higher average return. As a result of this rearranging, Missy

b. raised firm-specific risk, but not market risk.

A University of Iowa basketball standout is offered a choice of contracts by the New York Liberty. The first one gives her $100,000 one year from today and $100,000 two years from today. The second one gives her $132,000 one year from today and $66,000 two years from today. As her agent, you must compute the present value of each contract. Which of the following interest rates is the lowest one at which the present value of the second contract exceeds that of the first?

a. 7 percent

According to the efficient markets hypothesis, the number of people who think a stock is overvalued exactly balances the number of people who think a stock is undervalued.

a. True

Historically, stocks have offered higher rates of return than bonds.

a. True

If a savings account pays 5 percent annual interest, then the rule of 70 tells us that the account value will double in approximately 14 years.

a. True

Which of the following make(s) insurance premiums higher than otherwise?

a. adverse selection and moral hazard

Diminishing marginal utility of wealth implies that the utility function is

a. upward-sloping and has decreasing slope.

Suppose you win a small lottery and you are given the following choice: You can (1) receive an immediate payment of $10,000 or (2) three annual payments, each in the amount of $3,600, with the first payment coming one year from now, the second two years from now, and the third three years from now. You would choose to take the three annual payments if the interest rate is

b. 3 percent, but not if the interest rate is 4 percent.

The present value of a payment of $500 to be made two years from today is greater if the interest rate is 7% than if it is 6%.

b. False

A risk-averse person has

b. a utility function whose slope gets flatter as wealth rises. This means they have diminishing marginal utility of wealth.

Kayla faces risks and she pays a fee to ABC Company; in return, ABC Company agrees to accept some or all of Kayla's risks. ABC Company is

b. an insurance company.

If a person is risk averse, then as wealth increases, total utility of wealth

b. increases at a decreasing rate.

Risk-averse people will choose different asset portfolios than people who are not risk averse. Over a long period of time, we would expect that

d. the average risk-averse person will earn a lower rate of return than the average non-risk-averse person.

As the number of stocks in a person's portfolio increases,

d. the risk of the portfolio decreases, as indicated by the decreasing value of the standard deviation of the portfolio.

You may be unwilling to buy a used car because you suspect the last owner found out the car was a lemon. You may treat a car you rented with a little less care than you would use on your own car.

c. The first example primarily illustrates adverse selection; the second primarily illustrates moral hazard.

Recently, Lisa's wealth increased by $500. If her wealth were to increase by another $500 in the near future, then her utility would increase, but not by as much as it increased with the recent increase to her wealth. Based on this information, Lisa's utility function

c. is upward sloping and her marginal utility function is downward sloping.

Which of the following is the correct way to compute the future value of $100 put into an account that earns 4 percent interest for 10 years?

d. $100(1 + .04)10

Rita puts $10,000 into each of two different assets. The first asset pays 10 percent interest and the second pays 5 percent. According to the rule of 70, what is the approximate difference in the value of the two assets after 14 years?

d. $20,000

A judge requires Harry to make a payment to Sally. The judge says that Harry can pay her either $10,000 today or $11,000 two years from today. Of the following interest rates, which is the lowest one at which Harry would be better off paying $11,000 two years from today?

d. 5 percent

Refer to Figure 27-2. From the appearance of the utility function, we know that

d. All of the above are correct.

Bert put $75 into an account and one year later had $100. What interest rate was paid on Bert's deposit?

d. None of the above is correct.