Chapter 14: Managerial Decision-Making Under Uncertainty
Old 30) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob is risk averse because A) his utility function is convex. B) he has negative marginal utility of wealth. C) he is willing to pay a premium to avoid a risky situation. D) All of the above.
C Skill: Conceptual AACSB: Analytical Thinking
Old 12) Best guesses of an event occurring in the future are based on A) estimates derived from the frequency of the event occurring in the past. B) coin flips. C) subjective probability. D) the wisdom of crowds.
C Skill: Definition AACSB: Application of Knowledge
Old 4) A fair bet is one where A) the player has a 50/50 chance of winning. B) the player's utility function is convex. C) the expected value is zero. D) the expected value is positive.
C Skill: Definition AACSB: Application of Knowledge
Old 28) If global warming began to cause random world-wide damage to crops, insurance companies A) would insure against specific crop failures. B) would not insure against specific crop failures. C) would be indifferent between insuring or not. D) would find themselves facing prosecution for ignoring the problem for so long.
B Skill: Conceptual AACSB: Analytical Thinking
New 10) If outcomes are ________, exactly one of the outcomes will occur and the probabilities add up to ________. A) probabilistic; between 0 and 1 B) exhaustive and mutually exclusive; 1 C) exhaustive; 1 D) mutually exclusive; between 0 and 1
B Skill: Conceptual AACSB: Application of Knowledge
New 13 Copyright © 2017 Pearson Education, Inc. 18) A risk-preferring person is willing to pay A) a risk premium. B) a fee to make a fair bet. C) to obtain decreasing marginal utility. D) None of the above.
B Skill: Conceptual AACSB: Application of Knowledge
New 13) Buying a diversified mutual stock fund allows you to A) completely avoid all types of risk. B) avoid only random, unsystematic risk. C) avoid only systematic risk. D) avoid risk only when all the stock prices are perfectly correlated.
B Skill: Conceptual AACSB: Application of Knowledge
New 15) Prospect theory can explain why A) people tend to gamble on long odds with small expected utility. B) people tend to sell their losing stocks and keep their winning stocks. C) people should only sell their losing stocks. D) people should never play the lottery.
B Skill: Conceptual AACSB: Application of Knowledge
New 2) If an individual makes her investment decisions based solely on the Expected Value criterion, one can conclude that she is A) risk averse. B) risk neutral. C) risk loving. D) extremely wealthy.
B Skill: Conceptual AACSB: Application of Knowledge
New 20) Insurance companies do NOT offer fair insurance because A) they are run by greedy capitalists. B) they could not stay in business. C) they cannot diversify their risks. D) they are risk-avoiding.
B Skill: Conceptual AACSB: Application of Knowledge
New 26 Copyright © 2017 Pearson Education, Inc. 3) A risk-neutral individual will make investment decisions purely based on expected value because A) she doesn't care about utility. B) utility is a linear function of wealth. C) she loves to take risk. D) expected value is always more than expected utility.
B Skill: Conceptual AACSB: Application of Knowledge
New 9) What is one reason a gambler might bet $1,000 that a team that is ranked sixteenth will win the NCAA basketball tournament? A) irrationality B) overconfidence C) exuberance D) gambler's fallacy
B Skill: Conceptual AACSB: Application of Knowledge
Old 11) If two events are perfectly negatively correlated, then A) diversification can reduce but not eliminate risk. B) diversification can eliminate risk. C) diversification has no impact on risk. D) diversification cuts risk in half.
B Skill: Conceptual AACSB: Application of Knowledge
Old 16) One aspect of prospect theory is that people tend to A) be very risk averse to large gains. B) be very risk averse to losses. C) love losses more than gains. D) hate gains regardless of potential losses.
B Skill: Conceptual AACSB: Application of Knowledge
New 13) According to ________, people are often risk averse when it comes to gains and risk preferring when it comes to losses. A) prospect theory B) the reflection effect C) the certainty effect D) the framing effect
B Skill: Definition AACSB: Application of Knowledge
New 16) Expected value represents A) the actual payment one expects to receive. B) the average of all payments one would receive if one undertook the risky event many times. C) the payment one receives if he or she makes the correct decision. D) the payment that is most likely to occur.
B Skill: Definition AACSB: Application of Knowledge
New 2 Copyright © 2017 Pearson Education, Inc. 5) If an event is likely to occur, which probability is a reasonable estimate? A) 0.32 B) 0.79 C) 1 D) Not enough information to determine.
B Skill: Definition AACSB: Application of Knowledge
New 23) Variance is a measure of ________ and the higher the variance, ________. A) expected profit; the greater the profit B) risk; the greater the risk C) standard deviation; greater the standard deviation D) risk; the lower the risk
B Skill: Definition AACSB: Application of Knowledge
New 24) Variance is a measure of ________ and the lower the variance, ________. A) expected profit; the lower the profit B) risk; the lower the risk C) standard deviation; lower the standard deviation D) risk; the greater the risk
B Skill: Definition AACSB: Application of Knowledge
New 4) If an event is unlikely to occur, which probability is a reasonable estimate? A) 0 B) 0.23 C) 0.82 D) Not enough information to determine.
B Skill: Definition AACSB: Application of Knowledge
New 7) If Stock A sometimes increases and sometimes decreases in value when Stock B increases in value at the same time, they are A) negatively correlated. B) uncorrelated. C) positively correlated. D) random bets.
B Skill: Definition AACSB: Application of Knowledge
New 8) If Stock A sometimes increases and sometimes decreases in value when Stock B decreases in value at the same time, they are A) negatively correlated. B) uncorrelated. C) positively correlated. D) random bets.
B Skill: Definition AACSB: Application of Knowledge
Old 14.2 Attitudes Toward Risk 1) Expected utility is A) the maximum utility that a person can get from a set of possible outcomes. B) the probability-weighted mean of the utility gained from a set of possible outcomes. C) negative for risk-averse people. D) indeterminant for risk preferring people.
B Skill: Definition AACSB: Application of Knowledge
Old 15) Someone who is risk-neutral has A) diminishing marginal utility of wealth. B) constant marginal utility of wealth. C) increasing marginal utility of wealth. D) less marginal utility of wealth than someone who is risk-preferring.
B Skill: Definition AACSB: Application of Knowledge
Old 3) Making many risky bets A) reduces your expected value. B) is called risk-pooling and can reduce risk. C) is irrational. D) is called risk pooling and increases your expected value.
B Skill: Definition AACSB: Application of Knowledge
New 3) John derives more utility from having $1,000 than from having $100. From this, we can conclude that John A) is risk averse. B) is risk loving. C) is risk neutral. D) has a positive marginal utility of wealth.
D Skill: Conceptual AACSB: Analytical Thinking
Old 29) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob is risk averse because A) his utility function is concave. B) he has diminishing marginal utility of wealth. C) he is willing to pay a premium to avoid a risky situation. D) All of the above.
D Skill: Conceptual AACSB: Analytical Thinking
Old 8) Which of the following sets of outcomes is mutually exclusive? A) win, lose, tie B) employed full-time, employed part-time, unemployed C) married, single, widowed D) All of the above.
D Skill: Conceptual AACSB: Analytical Thinking
New 12) If two events are positively correlated but NOT perfectly correlated, then A) diversification is not necessary since there is no risk. B) diversification eliminates all risk. C) diversification does not reduce risk at all. D) diversification can reduce risk.
D Skill: Conceptual AACSB: Application of Knowledge
Old 17) Which of the following helps to reduce risk? A) Purchasing insurance B) Obtaining more information C) Diversifying D) All of the above.
D Skill: Conceptual AACSB: Application of Knowledge
Old 24) Which of the following losses to an individual would an insurance company NOT cover? A) The person's automobile is stolen. B) Fire destroys the person's home. C) The person's father dies. D) The person's country is invaded.
D Skill: Conceptual AACSB: Application of Knowledge
14.1 Assessing Risk 1) Probability A) is a number between 0 and 1, inclusive. B) indicates how likely an outcome is to occur. C) is larger the more likely the event is to occur. D) All of the above.
D Skill: Definition AACSB: Application of Knowledge
New 14.5 Behavioral Economics and Uncertainty 1) Behavioral economics under uncertainty documents that A) people's behavior often differs from what standard expected utility theory predicts. B) people's behavior can change with their circumstances. C) people might put considerable weight on certain outcomes. D) All of the above.
D Skill: Definition AACSB: Application of Knowledge
New 3) The gambler's fallacy is A) true in many games, such as flipping coins. B) a result of overconfidence. C) the false belief that past events affect current dependent outcomes. D) the false belief that past events affect current independent outcomes.
D Skill: Definition AACSB: Application of Knowledge
Old 35) What type of risk behavior does the person exhibit who is willing to pay $5 for the chance to bet $60 on a game where 20% of the time the bet returns $100, and 80% of the time returns $50? Explain.
This person is risk preferring. The bet is fair. The expected wealth of the person is the same whether or not the bet is made. However, this person is willing to pay $5 to make this fair bet. Skill: Analytical AACSB: Analytical Thinking
Old For the following, please answer "True" or "False" and explain why. 27) Expected value represents the average of all outcomes if one were to undertake the risky event many times over and over again.
True. The expected value is not expected on any one outcome, because it represents the average of many outcomes. Skill: Definition AACSB: Written and Oral Communication
New 11) Natasha is going to buy a risky asset that has an expected value of $62, which yields an expected utility of 146. Equivalently, she could get utility of 146 from a certainty equivalent of $43. What is Natasha's risk premium? A) $19 B) $43 C) $103 D) $105
A Skill: Analytical AACSB: Analytical Thinking
New 19) If your risk of losing your house to catastrophe is 25%, how much would fair insurance cost if your home were worth $1,000,000? A) $250,000 B) $750,000 C) $1,000,000 D) Unable to determine with the information given.
A Skill: Analytical AACSB: Analytical Thinking
Old 10 Copyright © 2017 Pearson Education, Inc. 6) John's utility from an additional dollar increases more when he has $1,000 than when he has $10,000. From this, we can conclude that John A) is risk averse. B) is risk loving. C) is risk neutral. D) has a negative marginal utility of wealth.
A Skill: Analytical AACSB: Analytical Thinking
Old 15 Copyright © 2017 Pearson Education, Inc. 24) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob's expected utility is A) a. B) b. C) c. D) d.
A Skill: Analytical AACSB: Analytical Thinking
Old 19) Bob invests $75 in an investment that has a 50% chance of being worth $100 and a 50% chance of being worth $0. From this information we can conclude that Bob is A) risk preferring. B) risk neutral. C) risk averse. D) irrational.
A Skill: Analytical AACSB: Analytical Thinking
New 3 Copyright © 2017 Pearson Education, Inc. 9) Which of the following sets of outcomes is exhaustive? A) win, lose, tie B) employed full-time, employed part-time, unemployed C) married, single, widowed D) All of the above.
A Skill: Conceptual AACSB: Analytical Thinking
Old 14.3 Reducing Risk 1) Taking actions that reduce risk A) raise your expected value. B) makes you less risk-averse. C) are impractical in most circumstances. D) change your utility function.
A Skill: Conceptual AACSB: Analytical Thinking
Old 24 Copyright © 2017 Pearson Education, Inc. 26) 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? A) The risk of wind damage is potentially diversifiable but the risk of flooding is not. B) The risk of flood damage is potentially diversifiable but the risk of wind damage is not. C) predatory insurance policies D) Neither the risk of wind damage or the risk of flooding is diversifiable.
A Skill: Conceptual AACSB: Analytical Thinking
Old 25 Copyright © 2017 Pearson Education, Inc. 29) What is one reason the federal government might "bail out" farmers in flood prone areas of the country? A) Such flooding is not diversifiable and therefore only non-profit entities, such as the federal government, can cover the risks. B) Such flooding is diversifiable, but insurance company CEOs are more concerned with their stock-holder wealth than the well-being of farmers. C) Such flooding is diversifiable, but the market for such insurance policies cannot clear without the assistance of the International Community. D) Such flooding is known to happen on a regular basis and therefore there is no "risk" to be insured against.
A Skill: Conceptual AACSB: Analytical Thinking
Old 27) Farmers who purchase insurance against crop failures tend to be pooled with farmers far away. Why might this be the case? A) The weather in a single geographic area represents idiosyncratic risk, which is diversifiable. B) The weather in a single geographic area represents systematic risk, which is not diversifiable. C) The weather in far-flung geographic areas represents systematic risk, which is not diversifiable. D) The weather in far-flung geographic areas are commonly positively correlated.
A Skill: Conceptual AACSB: Analytical Thinking
New 11) Framing often causes people to A) violate expected utility theory. B) go to prison. C) fall afoul of the certainty effect. D) become risk-averse.
A Skill: Conceptual AACSB: Application of Knowledge
New 15) A stock mutual fund is generally A) less risky than buying individual stocks. B) more risky than buying individual stocks. C) just as risky as buying individual stocks. D) a way for the rich to avoid taxes.
A Skill: Conceptual AACSB: Application of Knowledge
New 18 Copyright © 2017 Pearson Education, Inc. 2) Searching the Internet for information to help select a product that is more reliable is most likely to be done by a A) risk-averse person. B) risk-neutral person. C) risk-preferring person. D) This cannot be determined with the information provided.
A Skill: Conceptual AACSB: Application of Knowledge
New 22) From the expected value of a game, we A) cannot determine the risk. B) can determine the risk. C) can determine exactly how much a player will receive. D) can infer the subjective probabilities of each possible outcome.
A Skill: Conceptual AACSB: Application of Knowledge
New 9 Copyright © 2017 Pearson Education, Inc. 2) The key economic difference between expected utility and expected value is that A) expected value only considers the value of outcomes, whereas expected utility considers the tradeoff between value and risk. B) expected utility only considers the value of outcomes, whereas expected value considers the tradeoff between value and risk. C) expected utility is the maximum value obtained, whereas expect value is the mean of the values from a set of possible outcomes. D) None of the above—the differences are mathematical not economic.
A Skill: Conceptual AACSB: Application of Knowledge
New 9) The ability of diversification to reduce risk A) is greater the more negatively correlated the two events are. B) is greater the more positively correlated the two events are. C) is greater the more uncorrelated the two events are. D) is greater the more risk averse the individual is.
A Skill: Conceptual AACSB: Application of Knowledge
Old 23) If fair insurance is offered to a risk-averse person, she will A) buy enough insurance to eliminate all risk. B) not buy any insurance because it is overpriced. C) not buy any insurance since the marginal utility of the amount of the payment is positive. D) buy enough insurance to cover about half of the possible loss.
A Skill: Conceptual AACSB: Application of Knowledge
Old 25) Insurance companies do NOT cover losses that would A) happen to all of the policyholders at once. B) happen with a very low probability. C) happen to just a handful of policyholders. D) happen with uncertainty.
A Skill: Conceptual AACSB: Application of Knowledge
Old 5) With regards to an investment project, which of the following is TRUE? A) A risk-neutral individual is more likely to invest than a risk-averse individual. B) A risk-neutral individual is more likely to invest than a risk-loving individual. C) A risk-neutral individual is less likely to invest than a risk-averse individual. D) Not enough information is given.
A Skill: Conceptual AACSB: Application of Knowledge
New 13) If a person is risk neutral, then she A) is indifferent about taking a fair bet. B) will pay a premium to avoid a fair bet. C) has a horizontal utility function. D) has zero marginal utility of wealth.
A Skill: Definition AACSB: Application of Knowledge
New 15) A(n) ________ relates each possible outcome to its probability of occurrence. A) probability distribution B) frequency C) expected value D) coin toss
A Skill: Definition AACSB: Application of Knowledge
New 19 Copyright © 2017 Pearson Education, Inc. 6) If Stock A increases in value when Stock B decreases in value at the same time, they are A) negatively correlated. B) uncorrelated. C) positively correlated. D) in different industries.
A Skill: Definition AACSB: Application of Knowledge
New 22 Copyright © 2017 Pearson Education, Inc. 18) Fair insurance A) has an expected value for the policy holder of zero. B) has a positive expected value for the insurance company. C) has very high insurance premiums. D) is available only to those who fully insure.
A Skill: Definition AACSB: Application of Knowledge
New 3) If an event will NOT occur, it has a probability (pr) of A) 0. B) 0 < pr < 1. C) 1. D) Not enough information to determine.
A Skill: Definition AACSB: Application of Knowledge
Old 8) Someone who is risk-averse has A) diminishing marginal utility of wealth. B) constant marginal utility of wealth. C) increasing marginal utility of wealth. D) less marginal utility of wealth than someone who is risk-neutral.
A Skill: Definition AACSB: Application of Knowledge
New 12) Natasha is going to buy a risky asset that has an expected value of $62, which yields an expected utility of 146. Her risk premium is $19. What is her certainty equivalent? A) $19 B) $43 C) $81 D) $208
B Skill: Analytical AACSB: Analytical Thinking
New 5) Which of the following games involving the roll of a single die is a fair bet? A) Bet $1 and receive $1 if 3 or 4 comes up. B) Bet $1 and receive $1 if 3, 4, or 5 comes up. C) Bet $1 and receive $4 if 6 comes up. D) None of the bets is a fair bet.
B Skill: Analytical AACSB: Analytical Thinking
New 6) If there are 10,000 people in your age bracket, and 10 of them died last year, an insurance company believes that the probability of someone in that age bracket dying this year would be A) 0. B) .001. C) .0001. D) 1,000.
B Skill: Analytical AACSB: Analytical Thinking
New 7) A jar has 20 red jelly beans and 40 black jelly beans. If you pick a red jelly bean and put it back, what are the odds of picking a red jelly bean next? A) 20/40 B) 20/60 C) 40/60 D) 0
B Skill: Analytical AACSB: Analytical Thinking
New 7) People in a certain group have a 0.3% chance of dying this year. If a person in this group buys a life insurance policy for $3,300 that pays $1,000,000 to her family if she dies this year and $0 otherwise, what is the expected value of a policy to the insurance company? A) $0 B) $300 C) $3,000 D) $3,300
B Skill: Analytical AACSB: Analytical Thinking
Old 16 Copyright © 2017 Pearson Education, Inc. 28) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. If Bob could keep $50 with certainty, his utility would be A) a. B) b. C) c. D) d.
B Skill: Analytical AACSB: Analytical Thinking
Old 19) On any given day we know a salesman can earn $0 with a 30% probability, $100 with a 20% probability or $300 with 40% probability. His expected earnings equal A) $0. B) $140. C) $300. D) It cannot be determined from the available information.
B Skill: Analytical AACSB: Analytical Thinking
Old 25) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob's expected wealth is A) $0. B) $50. C) $75. D) $100.
B Skill: Analytical AACSB: Analytical Thinking
New 26) All else held constant, as the variance of a payoff increases, the A) expected value of the payoff increases. B) risk of the payoff increases. C) expected value of the payoff decreases. D) risk of the payoff decreases.
B Skill: Conceptual AACSB: Analytical Thinking
New 4 Copyright © 2017 Pearson Education, Inc. 13) Although he is very poor, Al plays the million-dollar lottery everyday because he is certain that one day he will win. Al makes this calculation based upon A) the frequency of past outcomes. B) subjective probability. C) knowledge of all possible outcomes. D) tossing a coin.
B Skill: Conceptual AACSB: Analytical Thinking
New 8) Sports announcers often refer to a baseball batter in a hitting slump as "being due." If they are correct, then it must be the case that A) a batter's hits are randomly distributed. B) a batter's at-bats are related to each other. C) a batter's at-bats are independent of each other. D) baseball players are acting irrationally.
B Skill: Conceptual AACSB: Analytical Thinking
New 9) Rahul has a concave utility function. Therefore, if there are two choices he will pick the ________ if ________ expected value. A) fair bet; both have the same B) less risky choice;both have the same C) more risky choice; both have the same D) less risky choice; it has a lower
B Skill: Conceptual AACSB: Analytical Thinking
Old 14) Your friend Dimitre tells you that he thinks that his favorite basketball team has a 70% chance of winning the next game. This is an example of a(n) A) objective probability. B) subjective probability. C) risk-averse statement. D) Friedman-Savage preference.
B Skill: Conceptual AACSB: Analytical Thinking
Old 27 Copyright © 2017 Pearson Education, Inc. 2) The gambler's fallacy suggests that what happened in the past will influence the present. Suffering from the gambler's fallacy is most likely TRUE in which of the following situations? A) flipping cards from a single deck B) tossing a fair coin C) the quality of play of a baseball team D) horse racing
B Skill: Conceptual AACSB: Analytical Thinking
New 20) If a person is entertained by gambling, then A) she is not risk averse. B) she does not understand the concept of a fair game. C) she may gamble even if it is an unfair game. D) she will definitely not buy automobile insurance.
C Skill: Conceptual AACSB: Analytical Thinking
New 23) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. The midpoint of the chord that runs from zero and intersects the utility function where wealth is 100, represents Bob's A) risk premium. B) expected utility of receiving $50 with certainty. C) expected utility of receiving $0 50% of the time and $100 50% of the time. D) risk neutrality.
C Skill: Analytical AACSB: Analytical Thinking
New 28 Copyright © 2017 Pearson Education, Inc. 6) A jar has 20 red jelly beans and 40 black jelly beans. If you pick a red jelly bean and put it back, what are the odds of picking a black jelly bean next? A) 20/40 B) 20/60 C) 40/60 D) 1 (100%)
C Skill: Analytical AACSB: Analytical Thinking
New 5) If you have flipped a fair coin and tails has come up 49 times in a row, what are the odds that the next flip will be a head? A) 1/50 B) 1/25 C) 1/2 D) 1 (100%)
C Skill: Analytical AACSB: Analytical Thinking
New 7 Copyright © 2017 Pearson Education, Inc. 25) A lottery game pays $500 with .001 probability and $0 otherwise. The variance of the payout is A) 15.8. B) 249.50. C) 249.75. D) 499.
C Skill: Analytical AACSB: Analytical Thinking
Old 20) Sarah buys little stuffed animals for $5 each. They come in different varieties. If the producer stops making (retires) a certain variety, a stuffed animal of that variety will be worth $100; otherwise it is worth $0. There is 50% chance that any variety will be retired. When Sarah buys her next stuffed animal, the expected value is A) $50. B) $47.50. C) $45.00. D) $0.
C Skill: Analytical AACSB: Analytical Thinking
Old 21) Bob invests $50 in an investment that has a 50% chance of being worth $100 and a 50% chance of being worth $0. From this information we can conclude that Bob is NOT A) risk preferring. B) risk neutral. C) risk averse. D) rational.
C Skill: Analytical AACSB: Analytical Thinking
Old 26) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Living with this risk gives Bob the same expected utility as if there was no chance of theft and his wealth was A) $0. B) $20. C) $30. D) $50.
C Skill: Analytical AACSB: Analytical Thinking
Old 27) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. What is the most Bob would pay for insurance that would replace his $100 should it be stolen? A) $30 B) $50 C) $70 D) $75
C Skill: Analytical AACSB: Analytical Thinking
Old 31) The above figure shows Bob's utility function. He currently has $100 of wealth, but there is a 50% chance that it could all be stolen. Bob will buy theft insurance to cover the full $100 A) as long as it does not cost more than $25. B) as long as it does not cost more than $50. C) as long as it does not cost more than $70. D) at any price.
C Skill: Analytical AACSB: Analytical Thinking
Old 5 Copyright © 2017 Pearson Education, Inc. 17) On any given day, a salesman can earn $0 with a 20% probability, $100 with a 40% probability, or $300 with a 20% probability. His expected earnings equal A) $0. B) $100 because that is the most likely outcome. C) $100 because that is what he will earn on average. D) $200 because that is what he will earn on average.
C Skill: Analytical AACSB: Analytical Thinking
Old 6 Copyright © 2017 Pearson Education, Inc. 21) Sarah buys little stuffed animals for $5 each. They come in different varieties. If the producer stops making (retires) a certain variety, a stuffed animal of that variety will be worth $100; otherwise it is worth $0. There is 50% chance that any variety will be retired. For the purchase of an individual stuffed animal, what is the value to Sarah of knowing ahead of time whether the variety will be retired? A) $50 B) $5 C) $2.50 D) $0
C Skill: Analytical AACSB: Analytical Thinking
Old 7) Catherine is risk-averse. When faced with a choice between a gamble and a certain level of wealth she will A) always prefer the gamble. B) always prefer the certain level of wealth. C) prefer the gamble if the expected utility from it is higher than the utility from the certain level of wealth. D) prefer the certain level of wealth if the expected utility from the gamble is higher than the utility of the certain level of wealth.
C Skill: Conceptual AACSB: Analytical Thinking
New 11) You draw colored balls out of a bag. You draw a red ball 30% of the time and a blue ball 70% of the time. For each draw, the blue outcome and the red outcome are A) mutually exclusive. B) exhaustive. C) Both A and B. D) None of the above.
C Skill: Conceptual AACSB: Application of Knowledge
New 12 Copyright © 2017 Pearson Education, Inc. 14) For a risk-neutral person, the expected utility associated with various levels of wealth A) is above the person's utility function. B) is below the person's utility function. C) is equal to the person's utility function. D) does not exist.
C Skill: Conceptual AACSB: Application of Knowledge
New 16) A person who is risk-neutral will A) pay a small risk premium when making a choice. B) pick a slightly less risky option with a slightly lower expected value. C) pick the option with the highest expected value. D) None of the above.
C Skill: Conceptual AACSB: Application of Knowledge
New 21) Insurance companies offer only unfair insurance because A) they are run by greedy capitalists. B) they can fool customers into buying it. C) they have operating costs. D) their risks are positively correlated.
C Skill: Conceptual AACSB: Application of Knowledge
New 23 Copyright © 2017 Pearson Education, Inc. 22) Many people do NOT fully insure against risk because A) they are risk averse. B) the insurance companies are all crooks. C) the insurance offered is less than fair. D) the insurance offered is more than fair.
C Skill: Conceptual AACSB: Application of Knowledge
New 30 Copyright © 2017 Pearson Education, Inc. 14) The certainty effect shows that A) people are overconfident about their choices. B) people prefer certain outcomes to uncertain outcomes even when the expected value of the uncertain outcome is lower. C) people prefer certain outcomes to uncertain outcomes even when the expected value of the uncertain outcome is higher. D) people prefer certain outcomes to uncertain outcomes even when the expected values are the same.
C Skill: Conceptual AACSB: Application of Knowledge
New 4) Risk-averse individuals make risky investments A) never. B) when the investment's expected return exceeds the return on a non-risky investment. C) when the investment's expected return adequately compensates for the risk. D) only when they are feeling irrational.
C Skill: Conceptual AACSB: Application of Knowledge
Old 14.4 Investing Under Uncertainty 1) A risk-neutral person will invest in a project by examining if A) the expected utility associated with the project is positive. B) the marginal utility associated with the project is positive. C) the expected value is positive. D) All of the above.
C Skill: Conceptual AACSB: Application of Knowledge
Old 16) A stock mutual fund's primary advantage is to allow A) investors to diversify away systematic risk. B) investors to diversify away all risk. C) investors to diversify away idiosyncratic risk. D) the rich to avoid taxes.
C Skill: Conceptual AACSB: Application of Knowledge
Old 20 Copyright © 2017 Pearson Education, Inc. 10) If two events are perfectly positively correlated, then A) diversification is not necessary since there is no risk. B) diversification eliminates all risk. C) diversification does not reduce risk at all. D) diversification only cuts the risk in half.
C Skill: Conceptual AACSB: Application of Knowledge
Old 21 Copyright © 2017 Pearson Education, Inc. 14) In terms of the stock market, systematic risk refers to the fact that A) some stocks have higher returns than others. B) some stocks' returns have a higher variance than others. C) all stock prices are correlated with the health of the economy. D) most stock prices are perfectly negatively correlated.
C Skill: Conceptual AACSB: Application of Knowledge
Old 29 Copyright © 2017 Pearson Education, Inc. 10) Politicians often highlight the plight of a single individual as a reason to support a particular project or agenda. In this case, politicians are using A) the Khaneman effect. B) the Allais effect. C) framing. D) prospect theory.
C Skill: Conceptual AACSB: Application of Knowledge
New 11 Copyright © 2017 Pearson Education, Inc. 10) A risk premium A) is required to get a risk-neutral person to make a fair bet. B) is the maximum amount needed to compensate a decision-maker to willingly take a risk. C) is the maximum amount a decision-maker would pay to avoid taking a risk. D) is the minimum amount a decision-maker would pay to avoid taking a risk.
C Skill: Definition AACSB: Application of Knowledge
New 12) According to the reflection effect A) people think harder about losses than about gains. B) people become more risk preferring over time. C) attitudes toward risk are reversed for gains versus loses. D) subjective probabilities on riskier outcomes are weighted heavier than on less risky outcomes.
C Skill: Definition AACSB: Application of Knowledge
New 17) Someone who is risk-preferring has A) diminishing marginal utility of wealth. B) constant marginal utility of wealth. C) increasing marginal utility of wealth. D) less marginal utility of wealth than someone who is risk-preferring.
C Skill: Definition AACSB: Application of Knowledge
New 2) If an event is certain to occur, it has a probability (pr) of A) 0. B) 0 < pr < 1. C) 1. D) Not enough information to determine.
C Skill: Definition AACSB: Application of Knowledge
New 4) If Stock A and Stock B both increase in value at the same time, they are A) negatively correlated. B) uncorrelated. C) positively correlated. D) certain bets.
C Skill: Definition AACSB: Application of Knowledge
New 5) If Stock A and Stock B both decrease in value at the same time, they are A) negatively correlated. B) uncorrelated. C) positively correlated. D) bad bets.
C Skill: Definition AACSB: Application of Knowledge
New 14 Copyright © 2017 Pearson Education, Inc. 22) Bob invests $25 in an investment that has a 50% chance of being worth $100 and a 50% chance of being worth $0. From this information we can conclude that Bob is A) risk preferring. B) risk neutral. C) risk averse. D) Any of the above.
D Skill: Analytical AACSB: Analytical Thinking
New 4) If you have flipped a fair coin and tails has come up 49 times in a row, what are the odds that the next flip will be a tail? A) 0 B) 1/50 C) 1/25 D) 1/2
D Skill: Analytical AACSB: Analytical Thinking
Old 18) On any given day, a salesman can earn $0 with a 30% probability, $100 with a 20% probability, or $300 with a 50% probability. His expected earnings equal A) $0. B) $100. C) $150. D) $170.
D Skill: Analytical AACSB: Analytical Thinking
Old 8 Copyright © 2017 Pearson Education, Inc. 29) On any given day, a salesman can earn $0 with a 20% probability, $100 with a 40% probability, or $300 with a 20% probability. Calculate the expected value and variance of his earnings, and interpret.
E(X) = (0 ∗ .2) + (100 ∗ .4) + (300 ∗ .2) = $100 Variance(X) = .2(0 - 100)2 + .4(100 - 100)2 + .2(300 - 100)2 = 2000 + 0 + 8000 = 10,000. E(X) tells us that her earnings will average $100 per day if she stays at this job over a long time period. The variance is a measure of how risky her income is. Skill: Analytical AACSB: Analytical Thinking
Old 33) A fair game is a game in which the chances are 50-50 that you win or lose.
False. A fair game is one in which the expected value of the payoff to the player is equal to the cost of playing. Skill: Conceptual AACSB: Written and Oral Communication
Old 17 Copyright © 2017 Pearson Education, Inc. For the following, please answer "True" or "False" and explain why. 32) If a person is risk averse, then she has negative marginal utility of wealth.
False. The marginal utility of wealth is positive for the risk-averse person; however, marginal utility diminishes as wealth increases. Skill: Conceptual AACSB: Written and Oral Communication
Old 28) For a given expected value, the smaller the standard deviation of the expected value, the larger the risk.
False. The smaller the standard deviation the smaller the associated risk. The standard deviation is the square root of the variance, thus the smaller the variance the smaller the standard deviation. The smaller the variance of the expected value the smaller the risk. Skill: Conceptual AACSB: Written and Oral Communication
Old 34) If a person willingly plays an unfair game that is NOT in his favor, he is risk loving.
False. While that could be the reason, there are others. Either the person likes gambling for entertainment reasons, or the person does not understand the probabilities associated with each payout. Skill: Conceptual AACSB: Written and Oral Communication
Old 30) Sarah buys little stuffed animals for $5 each. They come in different varieties. If the producer stops making (retires) a certain variety, a stuffed animal of that variety will be worth $100; otherwise it is worth $0. There is 25% chance that any variety will be retired. For the purchase of an individual animal, what is the value to Sarah of knowing ahead of time whether or not that variety will be retired?
If Sarah did not know whether a variety is to be retired, her expected value of a purchase is (.75 ∗ -5) + (.25 ∗ 95) = -3.75 + 23.75 = $20. If she knows ahead of time that a variety won't be retired, she won't buy one. So, her expected value becomes (.75 ∗ 0) + (.25 ∗ 95) = $23.75. The information that a variety will or will not be retired is worth $3.75 to her. Skill: Analytical AACSB: Analytical Thinking
Old 30) Explain why insurance companies usually do NOT offer earthquake insurance.
Insurance companies diversify their risk by covering many people who mostly have uncorrelated expected losses. However, an earthquake usually causes losses to many people in an area. Thus, earthquake losses are very much positively correlated and cannot be easily diversified. Insurance companies do not want to face losses they cannot easily diversify. Skill: Conceptual AACSB: Written and Oral Communication