Question 1

If the returns of two assets are perfectly positively correlated, an investor who puts half of his/her savings into each will:

Accepted Answer

A) reduce risk. 
B) have a higher expected return. 
C) not gain from diversification. 
D) reduce risk but lower the expected return. 
A) reduce risk. 
B) have a higher expected return. 
C) not gain from diversification. 
D) reduce risk but lower the expected return.

Question 2

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

Accepted Answer

It is impossible to toss two dice and ge

Question 3

Professional gamblers know that the odds are always in favor of the house (casinos).The fact that they gamble says they are:

Accepted Answer

A) irrational. 
B) risk-neutral. 
C) risk-averse. 
D) risk seekers. 
A) irrational. 
B) risk-neutral. 
C) risk-averse. 
D) risk seekers.

Question 4

If the probability of an outcome equals one, the outcome:

Accepted Answer

A) is more likely to occur than the others listed. 
B) is certain to occur. 
C) is certain not to occur. 
D) has unquantifiable risk. 
A) is more likely to occur than the others listed. 
B) is certain to occur. 
C) is certain not to occur. 
D) has unquantifiable risk.

Question 5

Hedging risk and spreading risk are two ways to:

Accepted Answer

A) increase expected returns from a portfolio. 
B) diversify a portfolio. 
C) lower transaction costs. 
D) match up perfectly positively correlated assets. 
A) increase expected returns from a portfolio. 
B) diversify a portfolio. 
C) lower transaction costs. 
D) match up perfectly positively correlated assets.

Question 6

In order to benefit from diversification, the returns on assets in a portfolio must:

Accepted Answer

A) be perfectly positively correlated. 
B) be perfectly negatively correlated. 
C) positively correlated but not perfectly. 
D) have the same idiosyncratic risks. 
A) be perfectly positively correlated. 
B) be perfectly negatively correlated. 
C) positively correlated but not perfectly. 
D) have the same idiosyncratic risks.

Question 7

Leverage:

Accepted Answer

A) reduces risk. 
B) is synonymous with risk-free investment. 
C) increases expected rate of return. 
D) leads to smaller changes in the investment's price. 
A) reduces risk. 
B) is synonymous with risk-free investment. 
C) increases expected rate of return. 
D) leads to smaller changes in the investment's price.

Question 8

When the home construction industry does poorly due to a recession, this is an example of:

Accepted Answer

A) systematic risk. 
B) idiosyncratic risk. 
C) risk premium. 
D) unique risk. 
A) systematic risk. 
B) idiosyncratic risk. 
C) risk premium. 
D) unique risk.

Question 9

A $500 investment has the following payoff frequency: half of the time it will pay $350 and the other half of the time it will pay $900.Its standard deviation and value at risk respectively are:

Accepted Answer

A) $275; $150 
B) $625; $275 
C) $275; $350 
D) $125; $500 
A) $275; $150 
B) $625; $275 
C) $275; $350 
D) $125; $500

Question 10

The standard deviation is generally more useful than the variance because:

Accepted Answer

A) it is easier to calculate. 
B) variance is a measure of risk, where standard deviation is a measure of return. 
C) standard deviation is calculated in the same units as payoffs and variance isn't. 
D) it can measure unquantifiable risk. 
A) it is easier to calculate. 
B) variance is a measure of risk, where standard deviation is a measure of return. 
C) standard deviation is calculated in the same units as payoffs and variance isn't. 
D) it can measure unquantifiable risk.

Question 11

The Russian wheat crop fails, driving up wheat prices in the U.S.This is an example of:

Accepted Answer

A) idiosyncratic risk. 
B) diversification. 
C) systematic risk. 
D) quantifiable risk. 
A) idiosyncratic risk. 
B) diversification. 
C) systematic risk. 
D) quantifiable risk.

Question 12

If an investment has a 20%(0.20) probability of returning $1,000; a 30%(0.30) probability of returning $1,500; and a 50%(0.50) probability of returning $1,800; the expected value of the investment is:

Accepted Answer

A) $1,433.33 
B) $1,550.00 
C) $2,800.00 
D) $1,600.00 
A) $1,433.33 
B) $1,550.00 
C) $2,800.00 
D) $1,600.00

Question 13

Apply the definition of risk provided in the textbook to an individual's decision to purchase a car insurance policy.Suppose that the individual has two possibilities: no accident ($0 gain/loss) and accident (-$30,000 loss).If the probability of an accident is lower than the probability of an accident occurring (say the probability of an accident is 10%), then why do people buy car insurance? How is this related to the concept of value at risk and the time horizon of investment decisions?

Accepted Answer

People buy car insurance in order to sha

Question 14

An automobile insurance company that writes millions of policies is practicing a form of:

Accepted Answer

A) mutual fund. 
B) hedging risk. 
C) spreading risk. 
D) eliminating systematic risk. 
A) mutual fund. 
B) hedging risk. 
C) spreading risk. 
D) eliminating systematic risk.

Question 15

The expected value of an investment:

Accepted Answer

A) is what the owner will receive when the investment is sold. 
B) is the sum of the payoffs. 
C) is the probability-weighted sum of the possible outcomes. 
D) cannot be determined in advance. 
A) is what the owner will receive when the investment is sold. 
B) is the sum of the payoffs. 
C) is the probability-weighted sum of the possible outcomes. 
D) cannot be determined in advance.

Question 16

A portfolio of assets has lower risk than holding one asset, but the same expected return and higher transaction costs.Which of the following statements is most correct?

Accepted Answer

A) The portfolio is attractive to people who are risk-averse and risk-neutral, but not to risk seekers. 
B) The portfolio is attractive to investors who are risk-neutral. 
C) The portfolio is not attractive to investors who are risk-neutral. 
D) The portfolio is attractive to investors who are risk seekers. 
A) The portfolio is attractive to people who are risk-averse and risk-neutral, but not to risk seekers. 
B) The portfolio is attractive to investors who are risk-neutral. 
C) The portfolio is not attractive to investors who are risk-neutral. 
D) The portfolio is attractive to investors who are risk seekers.

Question 17

Unexpected inflation can benefit some people/firms and harm others.This is an example of:

Accepted Answer

A) systematic risk. 
B) unmeasured risk. 
C) idiosyncratic risk. 
D) zero risk since the effects balance. 
A) systematic risk. 
B) unmeasured risk. 
C) idiosyncratic risk. 
D) zero risk since the effects balance.

Question 18

The greater the standard deviation of an investment the:

Accepted Answer

A) lower the return. 
B) greater the risk. 
C) lower the risk. 
D) lower the risk and return. 
A) lower the return. 
B) greater the risk. 
C) lower the risk. 
D) lower the risk and return.

Question 19

Diversification can eliminate:

Accepted Answer

A) all risk in a portfolio. 
B) risk only if the investor is risk averse. 
C) the systematic risk in a portfolio. 
D) the idiosyncratic risk in a portfolio. 
A) all risk in a portfolio. 
B) risk only if the investor is risk averse. 
C) the systematic risk in a portfolio. 
D) the idiosyncratic risk in a portfolio.

Question 20

An investment pays $1000 three quarters of the time, and $0 the remaining time.Its expected value and variance respectively are:

Accepted Answer

A) $1,000: 62,500 dollars2 
B) $750; 46,875 dollars 
C) $750; 62,500 dollars 
D) $750; 187,500 dollars2 
A) $1,000: 62,500 dollars2 
B) $750; 46,875 dollars 
C) $750; 62,500 dollars 
D) $750; 187,500 dollars2

Exam 5: Understanding Risk

If the returns of two assets are perfectly positively correlated, an investor who puts half of his/her savings into each will:

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

Professional gamblers know that the odds are always in favor of the house (casinos).The fact that they gamble says they are:

If the probability of an outcome equals one, the outcome:

Hedging risk and spreading risk are two ways to:

In order to benefit from diversification, the returns on assets in a portfolio must:

Leverage:

When the home construction industry does poorly due to a recession, this is an example of:

A $500 investment has the following payoff frequency: half of the time it will pay $350 and the other half of the time it will pay $900.Its standard deviation and value at risk respectively are:

The standard deviation is generally more useful than the variance because:

The Russian wheat crop fails, driving up wheat prices in the U.S.This is an example of:

If an investment has a 20%(0.20) probability of returning $1,000; a 30%(0.30) probability of returning $1,500; and a 50%(0.50) probability of returning $1,800; the expected value of the investment is:

An automobile insurance company that writes millions of policies is practicing a form of:

The expected value of an investment:

A portfolio of assets has lower risk than holding one asset, but the same expected return and higher transaction costs.Which of the following statements is most correct?

Unexpected inflation can benefit some people/firms and harm others.This is an example of:

The greater the standard deviation of an investment the:

Diversification can eliminate:

An investment pays $1000 three quarters of the time, and $0 the remaining time.Its expected value and variance respectively are:

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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