Question 1

An investor practicing hedging would be most likely to:

Accepted Answer

A) avoid the stock market and focus on bonds. 
B) purchase shares in general motors and buy U.S.treasury bonds. 
C) purchase shares in general motors and Amoco oil. 
D) put his/her invested funds in CDs. 
A) avoid the stock market and focus on bonds. 
B) purchase shares in general motors and buy U.S.treasury bonds. 
C) purchase shares in general motors and Amoco oil. 
D) put his/her invested funds in CDs.

Question 2

An investment with a large spread between possible payoffs will generally have:

Accepted Answer

A) a low expected return. 
B) a high standard deviation. 
C) a low value at risk. 
D) both a low expected return and a low value at risk. 
A) a low expected return. 
B) a high standard deviation. 
C) a low value at risk. 
D) both a low expected return and a low value at risk.

Question 3

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

Accepted Answer

Idiosyncratic risk can be redu

Question 4

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

Accepted Answer

Systematic risk is risk resulting from s

Question 5

Explain why a riskier asset offers a higher expected return.

Accepted Answer

Due to the higher risk, savers

Question 6

A risk-averse investor compared to a risk-neutral investor would:

Accepted Answer

A) offer the same price for an investment as the risk-neutral investor. 
B) require a higher risk premium for the same investment as a risk-neutral investor. 
C) place more focus on expected return and less on return than the risk-neutral investor. 
D) place less focus on expected return than the risk-neutral investor. 
A) offer the same price for an investment as the risk-neutral investor. 
B) require a higher risk premium for the same investment as a risk-neutral investor. 
C) place more focus on expected return and less on return than the risk-neutral investor. 
D) place less focus on expected return than the risk-neutral investor.

Question 7

An investment will pay $2,000 half of the time and $1,400 half of the time.The standard deviation for this investment is:

Accepted Answer

A) $90,000. 
B) $300. 
C) $1,700. 
D) $30. 
A) $90,000. 
B) $300. 
C) $1,700. 
D) $30.

Question 8

Spreading risk involves:

Accepted Answer

A) finding assets whose returns are perfectly negatively correlated. 
B) adding assets to a portfolio that move independently. 
C) investing in bonds and avoiding stocks during bad times. 
D) building a portfolio of assets whose returns move together. 
A) finding assets whose returns are perfectly negatively correlated. 
B) adding assets to a portfolio that move independently. 
C) investing in bonds and avoiding stocks during bad times. 
D) building a portfolio of assets whose returns move together.

Question 9

Which of the following statements is true?

Accepted Answer

A) Leverage increases expected return and increases risk. 
B) Leverage increases expected return and reduces risk. 
C) Leverage decreases expected return but has no effect on risk. 
D) Leverage decreases expected return and increases risk. 
A) Leverage increases expected return and increases risk. 
B) Leverage increases expected return and reduces risk. 
C) Leverage decreases expected return but has no effect on risk. 
D) Leverage decreases expected return and increases risk.

Question 10

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

Accepted Answer

In planning for retirement an individual

Question 11

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?

Accepted Answer

We can use the general formula:
Leverage

Question 12

An investor puts $2,000 into an investment that will pay $2,500 one-fourth of the time; $2,000 one-half of the time, and $1,750 the rest of the time.What is the investor's expected return?

Accepted Answer

A) 12.5% 
B) $250.00 
C) 6.25% 
D) 3.125% 
A) 12.5% 
B) $250.00 
C) 6.25% 
D) 3.125%

Question 13

Risk-free investments have rates of return:

Accepted Answer

A) equal to zero. 
B) with a standard deviation equal to zero. 
C) that are uncertain, but have a certain time horizon. 
D) that exhibit a large spread of potential payoffs. 
A) equal to zero. 
B) with a standard deviation equal to zero. 
C) that are uncertain, but have a certain time horizon. 
D) that exhibit a large spread of potential payoffs.

Question 14

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

Accepted Answer

This statement really isn't correct.A be

Question 15

Compute the expected return, standard deviation, and value at risk for each of the following investments:
Investment (A): Pays $800 three-fourths of the time and a $1200 loss otherwise.
Investment (B): Pays $1000 loss half of the time and a $1600 gain otherwise.
State which investment will be preferred by each of the following investors, and explain why.
(i) a risk-neutral investor.
(ii) an investor who seeks to avoid the worst-case scenario.
(iii) a risk-averse investor.

Accepted Answer

Investment (A)
Expected return = 0.25(-$

Question 16

Explain why insurance companies may find themselves at times having to refuse business.

Accepted Answer

Insurance companies accept risk from ind

Question 17

All other factors held constant, an investment:

Accepted Answer

A) with more risk should offer a lower return and sell for a higher price. 
B) with less risk should sell for a lower price and offer a higher expected return. 
C) with more risk should sell for a lower price and offer a higher expected return. 
D) with less risk should sell for a lower price and offer a lower return. 
A) with more risk should offer a lower return and sell for a higher price. 
B) with less risk should sell for a lower price and offer a higher expected return. 
C) with more risk should sell for a lower price and offer a higher expected return. 
D) with less risk should sell for a lower price and offer a lower return.

Question 18

Another name for the expected value of an investment would be the:

Accepted Answer

A) mean value. 
B) upper-end value. 
C) certain value. 
D) risk-free value. 
A) mean value. 
B) upper-end value. 
C) certain value. 
D) risk-free value.

Question 19

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.

Accepted Answer

The expected value =

Question 20

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.
E.L.= 0.1($150) + 0.9($0) = $15.00.Since this expected loss is less than the $40 in premium savings it makes good sense to increase the deductible.

Accepted Answer

An increase of a deductible from $100 to

Exam 5: Understanding Risk

An investor practicing hedging would be most likely to:

An investment with a large spread between possible payoffs will generally have:

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

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

Explain why a riskier asset offers a higher expected return.

A risk-averse investor compared to a risk-neutral investor would:

An investment will pay $2,000 half of the time and $1,400 half of the time.The standard deviation for this investment is:

Spreading risk involves:

Which of the following statements is true?

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

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?

An investor puts $2,000 into an investment that will pay $2,500 one-fourth of the time; $2,000 one-half of the time, and $1,750 the rest of the time.What is the investor's expected return?

Risk-free investments have rates of return:

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

Explain why insurance companies may find themselves at times having to refuse business.

All other factors held constant, an investment:

Another name for the expected value of an investment would be the:

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.

An Introduction to Money and the Financial System

Money and the Payments System

Financial Instruments, Financial Markets, and Financial Institutions

Future Value, Present Value, and Interest Rates

Bonds, Bond Prices, and the Determination of Interest Rates

The Risk and Term Structure of Interest Rates

Stocks, Stock Markets, and Market Efficiency

Derivatives: Futures, Options, and Swaps

Foreign Exchange

The Economics of Financial Intermediation

Depository Institutions: Banks and Bank Management

Financial Industry Structure

Regulating the Financial System

Central Banks in the World Today

The Structure of Central Banks: The Federal Reserve and the European Central Bank

The Central Bank Balance Sheet and the Money Supply Process

Monetary Policy: Stabilizing the Domestic Economy

Exchange-Rate Policy and the Central Bank

Money Growth, Money Demand, and Modern Monetary Policy

Output, Inflation, and Monetary Policy

Understanding Business Cycle Fluctuations

Modern Monetary Policy and the Challenges Facing Central Bankers

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