Question 1

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 2

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 3

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) Not be perfectly positively correlated 
D) Have the same idiosyncratic risks 
A) Be perfectly positively correlated 
B) Be perfectly negatively correlated 
C) Not be perfectly positively correlated 
D) Have the same idiosyncratic risks

Question 4

Sometimes spreading has an advantage over hedging to lower risk because:

Accepted Answer

A) It can be difficult to find assets that move predictably in opposite directions 
B) It is cheaper to spread than hedge 
C) Spreading increases expected returns, hedging does not 
D) Spreading does not affect expected returns 
A) It can be difficult to find assets that move predictably in opposite directions 
B) It is cheaper to spread than hedge 
C) Spreading increases expected returns, hedging does not 
D) Spreading does not affect expected returns

Question 5

High oil prices tend to harm the auto industry and benefit oil companies; therefore, high oil prices are an example of:

Accepted Answer

A) Systematic risk 
B) Idiosyncratic risk 
C) Neither systematic nor idiosyncratic risk 
D) Both systematic and idiosyncratic risk 
A) Systematic risk 
B) Idiosyncratic risk 
C) Neither systematic nor idiosyncratic risk 
D) Both systematic and idiosyncratic risk

Question 6

Discuss how well financial markets would work if people all had the exact same tolerance for risk.

Accepted Answer

Financial markets may not work nearly as

Question 7

Spreading 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 8

An investment pays $1,200 a quarter of the time; $1,000 half of the time; and $800 a quarter of the time.Its expected value and variance respectively are:

Accepted Answer

A) $1,000; 20,000 dollars 
B) $1,050; 20,000 dollars 
C) $1,000; 40,000 dollars 
D) $1,000; 80,000 dollars 
A) $1,000; 20,000 dollars 
B) $1,050; 20,000 dollars 
C) $1,000; 40,000 dollars 
D) $1,000; 80,000 dollars

Question 9

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 10

The expected return from a portfolio made up equally of two assets that move perfectly opposite of each other would have a standard deviation equal to:

Accepted Answer

A) 1.0 
B) -1.0 
C) 0.0 
D) 0.5 
A) 1.0 
B) -1.0 
C) 0.0 
D) 0.5

Question 11

A risk-neutral investor:

Accepted Answer

A) Highly values diversification 
B) Is the only type of investor who benefits from diversification 
C) Gains nothing from diversification 
D) Does not believe that diversification can reduce risk 
A) Highly values diversification 
B) Is the only type of investor who benefits from diversification 
C) Gains nothing from diversification 
D) Does not believe that diversification can reduce risk

Question 12

Explain why a company offering homeowners insurance policies would want to insure homes across a wide geographic area.

Accepted Answer

One of the lessons from this chapter is

Question 13

Explain why an asset that carries more risk should sell for a lower price but offer a higher expected return.

Accepted Answer

An asset that carries more risk will sel

Question 14

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 15

A life insurance company can make profits because individual life spans:

Accepted Answer

A) Are very similar 
B) Are independent 
C) Individual life spans are perfectly positively correlated 
D) Individual life spans are perfectly negatively correlated 
A) Are very similar 
B) Are independent 
C) Individual life spans are perfectly positively correlated 
D) Individual life spans are perfectly negatively correlated

Question 16

An automobile insurance company on average charges a premium that:

Accepted Answer

A) Equals the expected loss from each driver 
B) Is less than the expected loss from each driver 
C) Is greater than the expected loss from each driver 
D) Equals 1/(expected loss) of each driver 
A) Equals the expected loss from each driver 
B) Is less than the expected loss from each driver 
C) Is greater than the expected loss from each driver 
D) Equals 1/(expected loss) of each driver

Question 17

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 18

Which of the following individuals is least likely to use value at risk as an important factor in his/her investment decision?

Accepted Answer

A) An individual considering a mortgage to buy his first home 
B) A family considering purchasing health insurance 
C) A policy maker considering regulation of depository institutions 
D) A mutual fund manager choosing the allocation of investments in the fund's portfolio 
A) An individual considering a mortgage to buy his first home 
B) A family considering purchasing health insurance 
C) A policy maker considering regulation of depository institutions 
D) A mutual fund manager choosing the allocation of investments in the fund's portfolio

Question 19

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 20

Idiosyncratic risk:

Accepted Answer

A) Affects all firms in the economy 
B) Affects one or a few firms, not everyone 
C) Is fixed across all firms 
D) Impacts all firms in the same industry equally 
A) Affects all firms in the economy 
B) Affects one or a few firms, not everyone 
C) Is fixed across all firms 
D) Impacts all firms in the same industry equally

Exam 5: Understanding Risk

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

Leverage:

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

Sometimes spreading has an advantage over hedging to lower risk because:

High oil prices tend to harm the auto industry and benefit oil companies; therefore, high oil prices are an example of:

Discuss how well financial markets would work if people all had the exact same tolerance for risk.

Spreading involves:

An investment pays $1,200 a quarter of the time; $1,000 half of the time; and $800 a quarter of the time.Its expected value and variance respectively are:

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?

The expected return from a portfolio made up equally of two assets that move perfectly opposite of each other would have a standard deviation equal to:

A risk-neutral investor:

Explain why a company offering homeowners insurance policies would want to insure homes across a wide geographic area.

Explain why an asset that carries more risk should sell for a lower price but offer a higher expected return.

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

A life insurance company can make profits because individual life spans:

An automobile insurance company on average charges a premium that:

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

Which of the following individuals is least likely to use value at risk as an important factor in his/her investment decision?

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

Idiosyncratic risk:

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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