Ap ECON
Amanda talks with several different brokers at a social gathering. She hears the following advice from brokers A, B, and C. Which broker, if any, gave her incorrect advice?
Broker C: "Stocks with greater risks offer lower average returns."
Which of the following is correct concerning stock market irrationality?
Bubbles could arise, in part, because the price that people pay for stock depends on what they think someone else will pay for it in the future.
Scott Adams, creator of the comic strip Dilbert, has a theory that you should
Buy stock in the companies you hate the most.
By diversifying, the risk of holding stock
Can be reduced but not eliminated.On average over the past two centuries stocks paid a higher average real return than bonds.
According to the efficient market hypothesis
Changes in the prices of stock are not predictable. Evidence shows that index funds typically do better than managed funds.
Some people claim that stock follows a random walk. What does this mean?
Changes in the stock prices cannot be predicted from available information.
Writing in the Wall Street Journal in 2009, economist Jeremy Siegel argued that, in the years leading up to the financial crisis of 2008-2009,
Claims that prices observed in financial markets are mostly "wrong."
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.
FALSE
The future value of $1 saved today is $1/(1 + r).
FALSE
ZZL Corporation has the opportunity to undertake an investment project that will cost $20,000 today. If the interest rate is 20 percent and if the project will yield the company $30,000 in 3 years, then ZZL will undertake the project.
FALSE
A person who believes strongly in the use of fundamental analysis to choose a portfolio of stocks
Is interested in the likely ability of a corporation to pay dividends in the future.
The risk of a portfolio
Is positively related to the average return of the portfolio.
Which of the following is correct concerning diversification?
It only reduces firm-specific risk; much of the reduction comes from increasing the number of stocks in a portfolio to well above 30.
From the appearance of the utility function, we know that
Mary Ann would prefer to hold a portfolio of stocks with an average return of 8 percent and a standard deviation of 2 percent to a portfolio of stocks with an average return of 8 percent and a standard deviation of 5 percent.
Suppose the vertical distance between the points (0, A) and (0, B) is 5. If her wealth increased from $1,050 to $1,350, then
Mary Ann's subjective measure of her well-being would increase by less than 5 units.
When you rent a car, you might treat it with less care than you would if it were your own. This is an example of
Moral hazard
Which of the following is not consistent with efficient market hypothesis?
News has no effect on stock prices.
PZX Corporation has the opportunity to undertake an investment project that will cost $10,000 today and yield the company $13,310 in 3 years. PZX will forgo the project if the interest rate is higher than 10 percent.
TRUE
People who are risk averse dislike bad outcomes more than they like comparable good outcomes.
TRUE
Speculative bubbles may arise in part because the value of the stock to a stockholder depends on the final sale price.
TRUE
The concept of present value helps explain why the quantity of loanable funds demanded decreases when the interest rate increases.
TRUE
The market for insurance is an example of diversification.
TRUE
The market for insurance is one example of reducing risk by using diversification.
TRUE
The present value of any future sum of money is the amount that would be needed today, at current interest rates, to produce that future sum.
TRUE
The value of a stock depends on the ability of the company to generate dividends and the expected price of the stock when the stockholder sells her shares
TRUE
When the price of an asset rises above what appears to be its fundamental value, the market is said to be experiencing a speculative bubble.
TRUE
The efficient markets hypothesis implies
That all stocks are fairly valued all the time & no stock is a better buy than the other.
If unexpected news raised people's expectations of a corporation's future dividends and price, then before the price changes this corporation's stock would be
Undervalued, so its price would rise.
According to fundamental analysis, a saver should prefer to buy stocks that are
Undervalued. This means the price of the stock is low given the value of the corporation.
If stock prices follow a random walk, then stock investors can make large profits by
Using inside information.
Which of the following methods of picking stocks is not consistent with fundamental analysis?
Viewing individual stock prices as unpredictable.
From the appearance of the utility function, we know that Dexter
the property of diminishing marginal utility does not apply to Dexter.
From the appearance of Rob's utility function, we know that
the property of diminishing marginal utility does not apply to Rob.
As the number of stocks in a person's portfolio increases,
the risk of the portfolio decreases, as indicated by the decreasing value of the standard deviation of the portfolio.
Diminishing marginal utility of wealth implies that the utility function is
upward-sloping and has decreasing slope.
What is measured along the vertical axis?
utility
Economists have developed models of risk aversion using the concept of
utility and the associated assumption of diminishing marginal utility.
The problem of moral hazard arises because
after people buy insurance, they have less incentive to be careful about their risky behavior.
In effect, an annuity provides insurance
against the risk of living too long.
Which term is used to describe a situation in which the price of an asset rises about what appears to be its fundamental value?
"Speculative bubble."
If the interest rate is 7.5 percent, then what is the present value of $4,000 to be received in 6 years?
$2,591.85
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
$441.87
Suppose you put $500 into a bank account today. Interest is paid annually and the annual interest rate is 5.5 percent. The future value of the $500 is
$653.48 after 5 years and $854.07 after 10 years.
Let 0A represent the distance between the origin and point A; let AB represent the distance between point A and point B; etc. Which of the following ratios best represents the marginal utility per dollar when wealth increases from $400 to $600?
...
The largest reduction in a portfolio's risk is achieved when the number of stocks in the portfolio is increased from
1 to 10
A person who is risk averse might accept a 50% chance of losing $100 today in exchange for a 50% chance of winning $125 in two years if the interest rate was
11% but not 12%.
Over the past two centuries, the average annual rates of return were about
8 percent for stocks and about 3 percent for short-term government bonds.
Which of the following make(s) insurance premiums higher than otherwise?
Adverse selection and moral hazard.
Which of the following best illustrates moral hazard?
After a person obtains life insurance, she takes up skydiving.
Mary talked to several stockbrokers and made the following conclusions. Which, if any, of her conclusions are correct?
All Mary's conclusions are correct.
After the 1982 recession, the U.S. world economist Jeremy Siegel argued that, in the years leading up to the financial crisis of 2008-2009,
All are correct.
From the appearance of the utility function, we know that
All the above are correct
Risk aversion helps to explain various things we observe in the economy, including
All the above are correct
Which of the following games might a risk-averse person play?
All the above are correct.
Which of the following is correct concerning a risk-averse person?
All the above are correct.
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
An insurance company.
Dividends
Are cash payments that companies make to shareholders.
If you believe that stock prices follow a random walk, then probably you
Believe in the validity of the efficient markets hypothesis.
Consider the following two situations. Nicole accepts a job where she will be driving in dangerous traffic, so she seeks auto insurance. After Braden buys health insurance, he visits the gym less frequently. Which of these person's actions illustrates moral hazard?
Braden's but not Nicole's.
April, who currently owns stock in four companies, has decided to expand her portfolio by purchasing stock in virtually every company that sells stock. In doing so, April will
Decrease some, but not all, of the risk of her portfolio.
Diversifying
Decreases the standard deviation of the value of a portfolio indicating its risk has decreased.
Risk aversion simply means that people dislike bad things to happen.
FALSE
Risk-averse individuals like good things more than they dislike comparable bad things.
FALSE
Risk-averse persons will take no risks.
FALSE
Studies find that mutual fund managers who do well in one year are likely to do well the next year.
FALSE
The present value of $100 to be paid in two years is less than the present value of $100 to be paid in three years.
FALSE
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%.
FALSE
The rule of 70 applies to a growing savings account but not to a growing economy.
FALSE
The sooner a payment is received and the higher the interest rate, the greater the present value of a future payment.
FALSE
The idea of insurance
Is to share risk.
During a financial crisis the possibility of bank failures rose. An increase in the likelihood of a bank failing shifts demand for its stock
Left, so price falls.
A high-ranking corporate official of a well-known company is unexpectedly sentenced to prison for criminal activity in trading stocks. This should
Lower the price and lower the present value of the corporation's stock.
From the appearance of the utility function, we know that
Mary Ann is risk averse.
Svetlana is risk averse. Which of the following is correct about Svetlana?
None are correct.
If most people's utility functions look like Rob's utility function, then it is easy to explain why
None of the above are correct
The efficient markets hypothesis implies that
None of the above are correct,
Suppose that interest rates unexpectedly rise and that Carter Corporation announces that revenues from last quarter were down but not as much as the public had anticipated they would be down. According to the efficient markets hypothesis, which of the these things make the price of Carter Corporation Stock fall?
Only the interest rate rising.
Mary Beth is risk averse and has $1,000 with which to make a financial investment. She has three options. Option A is a risk-free government bond that pays 5 percent interest each year for two years. Option B is a low-risk stock that analysts expect to be worth about $1,102.50 in two years. Option C is a high-risk stock that is expected to be worth about $1,200 in four years. Mary Beth should choose
Option A
The available evidence indicates that
Outperforming the market on a consistent basis is extremely difficult to do.
If your research leads you to believe that the present value of a stock's dividend stream and future price is less than its price then you believe the stock is
Overvalued so you should not consider buying it.
In the 1990's, Fed Chairperson Alan Greenspan believed that the market was
Overvalued, but whether it was remains debatable.
Research studies have shown that
People tend to be overconfident when making investment decisions.
Angela reads financial advice columns and concludes the following. Which, if any, of her conclusions are incorrect?
People who are risk averse should never hold stock.
The value of a stick is based on the
Present values of the dividend stream and final price. As a result, the value of a stock falls when interest rates rise.
Which of the following is a source of market risk?
Real GDP varies over time & sales & profits move with the real GDP.
A measure of the volatility of a variable is its
Standard Deviation
According to the efficient market hypothesis, which of the following statements is not correct?
Stock market prices tend to rise today if they rose yesterday.
Actively managed mutual funds usually fail to outperform index funds, and this fact provides evidence in favor of the efficient markets hypothesis.
TRUE
A soup manufacturer unexpectedly announces that it has hired a new manager. It is widely believed that this manager will raise the profitability of the corporation. At the same time interest rates unexpectedly rise. Which of the above would tend to make the price of the stock rise?
The announcement but not the rise in interest rates.
A bank might make mortgages to people in different regions of the country. By doing so
The bank reduces the risk it faces of falling house prices in its region but not from falling prices in all regions.
An asset market is said to experience a speculative bubble when
The price if the asset rises above what appears to be its fundamental value.
Fundamental analysis is
The study of a company;s accounting statements & future prospects to determine its value.
Which of the following games might a risk-averse person play?
a game where she has a 60 percent chance of winning $1 and a 40 percent chance of losing $1
Which of the following is adverse selection?
a high-risk person being more likely to apply for insurance
A risk-averse person has
a utility curve that slopes upward and a marginal utility curve that slopes downward.
Marcus puts a greater proportion of his portfolio into government bonds. Marcus's action
decreases both risk and the average rate of return.
Manufacturers of Weightbegone are concerned that genetic advances in weight control might reduce the demand for their diet snacks. This is an example of
firm-specific risk, which will likely raise shareholders' demand for higher return.
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
is upward sloping and her marginal utility function is downward sloping.
From the standpoint of the economy as a whole, the role of insurance is
not to eliminate the risks inherent in life, but to spread them around more efficiently.
Phillip is a mortgage broker, who is paid by commission. When interest rates decline, he does a lot of business and earns a lot of money, as more people buy houses or refinance their mortgages. But when interest rates rise, business falls substantially. To diversify, Phillip should choose investments that
pay higher returns when interest rates rise and lower returns when interest rates fall.
By holding insurance a person
shares risk and so reduces the burden of risk.
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
the average risk-averse person will earn a lower rate of return than the average non-risk-averse person.
Which distance along the vertical axis represents the marginal utility of an increase in wealth from $600 to $800?
the distance between point B and point C
Ben decided to increase the number of stocks in his portfolio. In doing so, Ben reduced
the firm-specific risk, but not the market risk of his portfolio.
The field of finance primarily studies
the implications of time and risk for allocating resources over time.
For the person to whom this utility function applies,
the more wealth she has, the less utility she gets from an additional dollar of wealth.
For a risk averse person,
the pain of losing $1,000 on a bet exceeds the pleasure of winning $1,000 on a bet.
Suppose the person to whom this utility function applies begins with $600 in wealth. Starting from there,
the pain of losing $200 of her wealth would exceed the pleasure of adding $200 to her wealth.
Suppose Mary Ann begins with $1,050 in wealth. Starting from there,
the pain of losing $300 of her wealth would exceed the pleasure of adding $300 to her wealth.
Which of the following is not correct?
Insurance markets reduce risk, but not by diversification.
Suppose interest of 5% for two years can be earned on $1,000 saved today with no risk. What is the least amount a person would need to have a 50% chance of winning to be willing to face a 50% chance of losing $1,000 today and be considered risk averse?
$1,102.51 to be paid in two years
Suppose that Albert can buy a bond for $1,000 that matures in two years and pays Albert $1,102.5 with certainty. He is indifferent between this bond and one that has some risk but on which the interest rate is 3% higher. How much, to the nearest penny, does the riskier bond pay in two years?
$1,166.40.
Whenever the price of an asset rises above what appears to be its fundamental value, the market is said to be experiencing a
Speculative bubble.
If the stock prices follow a random walk, it means
Stock prices are just as likely to rise as to fall at any given time.
The efficient markets hypothesis says that
Stock prices follow a random walk.
Economists disagree as to whether
Stock prices reflect rational estimates of a company's true worth.
In general, as a person includes fewer stocks and more bonds in his portfolio,
Both risk & expected return fall.
Moral hazard is illustrated by people who take greater risks after they purchase insurance.
TRUE
Because the statistic called the standard deviation measures the volatility of a variable, it is used to measure the return of a portfolio.
FALSE
From the standpoint of the economy as a whole, the role of insurance is to greatly reduce or eliminate the risks inherent in life.
FALSE
If a person had increasing marginal utility, then the decline in utility from losing $1,000 would be greater than the increase in utility from gaining $1,000.
FALSE
If you wish to rely on fundamental analysis to choose a portfolio of stocks, then you have no choice but to do all the necessary research yourself.
FALSE
Increasing the number of corporations whose stocks are in your portfolio reduces market risk.
FALSE
Managed mutual funds usually outperform mutual funds that are supposed to follow some stock index.
FALSE
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.
2 is market risk; 3 is firm-specific risk
Which of the following statements is correct?
A high-risk person is more likely to apply for insurance than a low-risk person because a high-risk person would benefit more from insurance protection.
Which of the following actions best illustrates adverse selection?
A person intending to take up dangerous hobbies applies for life insurance.
Which of the following actions best illustrates moral hazard?
A person purchases homeowners insurance and then checks his smoke detector batteries less frequently.
Which of the following actions best illustrates adverse selection?
A person who has narrowly avoided many accidents applies for automobile insurance.
Point A represents a situation is which
All of the above are correct.
The financial system
All of the above are correct.
The properties exhibited by this utility function help to explain various things we observe in the economy, including
All the above are correct
Fundamental analysis determines the value of stock based on
All the above are correct.
By purchasing shares in a mutual fund that holds a portfolio of stocks, a person can
Benefit from fundamental analysis, since the mutual fund hires one or more individuals to perform fundamental analysis for the fund.
In the 1990's, Fed Chairperson Alan Greenspan questioned whether the stock market
Boom at the time reflected "irrational exuberance."
If a stock of bond is risky
Both A & B are correct.
Risk
Both A & B.
If Cara's utility falls more by losing $600 than it rises by gaining $600, she has
Decreasing marginal utility of wealth and is risk averse.
From the appearance of the graph, we know that
Dexter's level of satisfaction increases by more when his wealth increases from $1,001 to $1,002 than it does when his wealth increases from $1,000 to $1,001.
Suppose the vertical distance between the points (0, A) and (0, B) is 12. If his wealth increased from $1,300 to $1,800, then
Dexter's subjective measure of his well-being would increase by more than 12 units.
Which of the following is not correct?
Diversification can eliminate market risk but not firm-specific risk.
A company that can build a project that will cost $50,000, but returns $52,000 in one year would make a good decision by turning this project down if the interest rate were 3 percent.
FALSE
A person's subjective measure of well-being or satisfaction is called aversion.
FALSE
According to the efficient markets hypothesis, stocks follow a random walk so that stocks that increase in price one year are more likely to increase than decrease in the next year.
FALSE
Adverse selection is illustrated by people who take greater risks after they purchase insurance.
FALSE
An increase in the interest rate causes a decrease in the future value of $1,000 that you have in a bank account today.
FALSE
Samantha holds stocks in four companies. If she adds stocks of several more companies she will decrease
Firm specific risk but not market risk.
An increase in the number of corporations in a portfolio from 110 to 120 reduces
Firm-specific risk by less than an increase from 1 to 10
An increase in the number of corporations in a portfolio from 1 to 10 reduces
Firm-specific risk by more than an increase from 110-120.
People who hold well-diversified portfolios of stocks have greatly reduced or eliminated
Firm-specific risk, but still they have reason to worry about their wealth decreasing as a result of recessions.
Which of the following pairs of portfolios exemplifies the risk-return tradeoff?
For Portfolio A, the average return is 5 percent and the standard deviation is 15 percent; for Portfolio B, the average return is 8 percent and the standard deviation is 25 percent.
Which of the following defines an annuity?
For a fee, an insurance company provides you with regular income until you die.
When a person engages in detailed analysis of a company to determine its value, he or she is engaging in
Fundamental analysis
From the standpoint of the economy as a whole, the role of
Insurance is to spread risks around more efficiently.
Fundamental analysis shows that Moonlight Company is fairly valued. Then Moonlight Company unexpectedly improves its production techniques and unexpectedly hires a new CEO away from another very successful tea producer. Suppose this has no effect on the price of the stock of Moonlight Company.
Fundamental analysis would now show the corporation is undervalued. The fact that the price was unchanged is not consistent with the efficient markets hypothesis.
The possibility of speculative bubbles in the stock market arises in part because
Future streams of dividend payments are very hard to estimate.
According to the efficient markets hypothesis, which of the following would increase the price of stock in the Gerhardt Corporation?
Gerhardt announces that its profits were low, but not as low as the market had expected.
An index fund
Holds all the stocks in a given stock index.
Suppose Mary Ann begins with $1,050 in wealth. Which of the following coin-flip bets would she definitely not be willing to accept?
If it is "heads," she wins $150; if it is tails, she loses $150.
Which of the following is not correct about high rate return?
If you had information about corporation that no one else had, you could earn a very high rate of return. This contradicts the efficient market hypothesis.
The efficient markets hypothesis says that beating the market consistently is
Impossible. Many studies find that beating the market is, at best, extremely difficult.
If the efficient market hypothesis is correct, then
Index funds should typically beat managed funds, & usually do.
Which of the following is correct concerning index funds?
Index funds typically have a higher rate of return than managed funds. This tends to support the efficient market hypothesis.
Which of the following best illustrates diversification?
Instead of holding only the stocks of companies engaged in the banking business, a person decides to hold stock in a number of different companies producing different goods and services.
Stock market fluctuations
Often go hand in hand with fluctuations in the economy more broadly.
Diversification reduce
Only firm-specific risk.
A pharmaceutical company unexpectedly announces that it just developed an important new drug. This news should
Raise the price of the corporation's stock; if it does not the stock is undervalued.
Diversification
Reduced the likely fluctuation in a portfolio's return. Thus, the likely standard deviation of the portfolio's return is lower.
Other things the same, as the number of stocks in a portfolio rises,
Risk decreases and the standard deviation of the return falls.
Other things the same, as the stocks of a greater number of corporations are held in a portfolio,
Risk decreases at a decreasing rate.
From the appearance of Rob's utility function, we know that
Rob is not risk averse.
If more people think a corporation's stock is overvalued than think it is undervalued then there is a
Surplus, so its price will rise.
A person with diminishing marginal utility of wealth is risk averse.
TRUE
According to fundamental analysis, when choosing stocks for your portfolio, you should prefer undervalued stocks.
TRUE
According to the efficient markets hypothesis, at any moment in time, the market price is the best estimate of the company's value based on publicly available information.
TRUE
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.
TRUE
According to the rule of 70, if you earn an interest rate of 3.5 percent, your savings will double about every 20 years.
TRUE
As the interest rate increases, the present value of future sums decreases, so firms will find fewer investment projects profitable.
TRUE
Available evidence indicates that stock prices, even if not exactly a random walk, are very close to a random walk.
TRUE
Diversification can reduce firm-specific risk.
TRUE
Diversification cannot reduce market risk.
TRUE
Historically the return on stocks has been higher than the return on bonds. In part this reflects the higher risk from holding stock.
TRUE
Historically, stocks have offered higher rates of return than bonds.
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.
TRUE
If the interest rate is 8 percent, then the present value of $1,000 to be received in 4 years is $735.03.
TRUE
If you are faced with the choice of receiving $500 today or $800 6 years from today, you will be indifferent between the two possibilities if the interest rate is 8.148 percent.
TRUE
If you believe the stock market is informationally efficient, then it is a waste of time to engage in fundamental analysis.
TRUE
In the 15 years ending June 2010, most active portfolio managers failed to beat the market.
TRUE
Suppose that an increased risk of mortgage defaults lowers the expected profitability of banks. Then we would expect to see
The demand for bank stocks fall which would reduce the prices of bank stocks.
No particular stock is a better buy than any other stock if
The efficient markets hypothesis is correct.
Which of the following statements is correct?
The figure shows that the greater the risk, the greater the return.
Which of the following statements best describes the economist's view of finance and the financial system?
The financial system is very important to the functioning of the economy, and the tools of finance are often helpful to us as individuals when we find ourselves making certain decisions.
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'd use on your own car.
The first example primarily illustrates adverse selection; the second primarily illustrates moral hazard.
Financial intermediaries typically require mortgage borrowers to have homeowner's insurance and do credit checks before making the loan.
The insurance requirement is designed primarily to reduce the risk of moral hazard; the credit check is designed primarily to reduce adverse selection.
Which of the following is correct?
The larger the percentage of stock in a portfolio, the greater the risk, but the greater average return.
The word "efficient markets hypothesis" refers to the idea that
The stock market is "informationally efficient."
If the efficient markets hypothesis is correct, then
The stock market is informationally efficient.
If you are convinced that stock prices are impossible to predict from available information, then you probably also believe that
The stock market is informationally efficient.
In what way(s) does the graph differ from the usual case?-Dexter
The utility function shown here is bowed downward (convex), whereas in the usual case the utility function is bowed upward (concave).
Tami knows that people in her family die young, and so she buys life insurance. Preston knows he is a reckless driver and so he applies for automobile insurance.
These are both examples of adverse selection.
Suppose that fundamental analysis indicates a particular company's stock is overvalued.
This means its present value is less than its price. You shouldn't consider adding the stock to your portfolio.
David increases the number of companies in which he holds stocks.
This reduces risk's standard deviation and firm-specific risk.
Fundamental analysis shows that stock in Cedar Valley Furniture Corporation has a price that exceeds its present value.
This stock is overvalued; you shouldn't consider adding it to your portfolio.
Fundamental analysis shows that stock in Lodgefire Restaurants has a present value below its price.
This stock is overvalued; you shouldn't consider adding it to your portfolio.
Fundamental analysis shows that stock in Garske Software Corporation has a present value that is higher than its price.
This stock is undervalued; you should consider adding it to your portfolio.
If asset markets are driven by the "animal spirits" of investors, then
Those markets reflect irrational behavior.
Most financial decisions involve two related elements:
Time & risk
A risk-averse person has
a utility function whose slope gets flatter as wealth rises. This means they have diminishing marginal utility of wealth.
Diversification of a portfolio
can eliminate firm-specific risk, but it cannot eliminate market risk.
Given that Tamar is a risk-averse person, she might accept a bet with a 50 percent chance of losing $100 today if she had a 50 percent
chance of winning $110 in two years and the interest rate was 3%.
If Robert is risk-averse, then he will always
choose not to play a game where he has a 50 percent chance of winning $1 and a 50 percent chance of losing $1.
The utility function of a risk-averse person has a
positive slope but gets flatter as wealth increases.
The performance of index funds
provides evidence in support of the efficient markets hypothesis.
The last $2,000 of Rolanda's wealth adds less to her utility than the previous $2,000. Based on this information, Rolanda has
decreasing marginal utility of wealth and is risk averse.
If a person is risk averse, then she has
diminishing marginal utility of wealth, implying that her utility function gets flatter as wealth increases.
Dakota rearranges her portfolio so that it has a higher average return. In doing this rearranging, she
raised firm-specific risk, but not market risk.
From the appearance of the utility function, we know that Dexter
gains more satisfaction when his wealth increases by X dollars than he loses in satisfaction when his wealth decreases by X dollars.
A risk-averse person
has a utility curve where the slope decreases with wealth, and might take a bet with a 70 percent chance of wining $400 and a 30 per chance of losing $400.
If Matt's current wealth is $51,000, then
his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is risk averse.
If a person is risk averse, then as wealth increases, total utility of wealth
increases at a decreasing rate.
According to the efficient markets hypothesis, worse-than-expected news about a corporation will
lower the price of stock.
The utility function that is shown exhibits the property of diminishing
marginal utility
Suppose that Thom experiences a greater loss in utility if he loses $50 than he would gain in utility if he wins $50. This implies that Thom's
marginal utility diminishes as wealth rises, so he must be risk averse.
To diversify, a homeowner with a variable-rate mortgage should choose investments that
pay higher returns when interest rates rise and lower returns when interest rates fall.
