Deck 23: Decision Making and Risk

Question 1

Consider the following to answer the question(s) below:
A land owner is considering a community development project. Even though he realizes that the current market for housing is not very favourable, he believes that there will be an influx of retirees into the area within the next five years. He is trying to decide between two alternatives: (1) building detached homes in a planned retirement community or (2) building a smaller townhouse/condominium complex. Mortgage interest rates will affect his outcomes and the applicable payoff (in $ millions) table is shown below.
Suppose housing analysts predict that the probabilities for future mortgage interest rates going up, staying about the same, and going down are 0.35, 0.50 and 0.15, respectively. The expected value for building an active retirement community is

A) $2.5 million
B) $3.625 million
C) $2.75 million
D) $875,000
E) Indeterminate

Answer 1

C

Question 2

Consider the following to answer the question(s) below:
A farm owner who grows summer vegetables (e.g. tomatoes) must decide whether to employ additional pickers this season. If he does, he could hire either migrant workers or local teenagers who need summer employment. The migrant workers are more experienced, faster, but more expensive. Although the teenagers will work for less, they are not as experienced and tend to damage plants and produce. His profits, taking into account losses from unpicked perished or damaged produce, depend on whether there is a good or bad growing season. The payoffs are shown in the table below.
Using the maximin approach, which action should the farm owner choose?

Answer 2

The farm owner would choose to do no additional hiring.

Question 3

The expected value of perfect information is

A) $2.5 million
B) $3.625 million
C) $2.75 million
D) $875,000
E) Indeterminate

Answer 3

D

Question 4

Consider the following to answer the question(s) below:
A farm owner who grows summer vegetables (e.g. tomatoes) must decide whether to employ additional pickers this season. If he does, he could hire either migrant workers or local teenagers who need summer employment. The migrant workers are more experienced, faster, but more expensive. Although the teenagers will work for less, they are not as experienced and tend to damage plants and produce. His profits, taking into account losses from unpicked perished or damaged produce, depend on whether there is a good or bad growing season. The payoffs are shown in the table below.
Based on the expected value approach, the farmer should

A) hire migrant workers if the growing season is good
B) hire teenagers
C) not do any extra hiring
D) hire migrant workers
E) not do any extra hiring if the growing season is bad

Question 5

Compute the standard deviation for each action.

Question 6

Consider the following to answer the question(s) below:
A farm owner who grows summer vegetables (e.g. tomatoes) must decide whether to employ additional pickers this season. If he does, he could hire either migrant workers or local teenagers who need summer employment. The migrant workers are more experienced, faster, but more expensive. Although the teenagers will work for less, they are not as experienced and tend to damage plants and produce. His profits, taking into account losses from unpicked perished or damaged produce, depend on whether there is a good or bad growing season. The payoffs are shown in the table below.
Suppose the Farmers' Almanac predicts the probability of a good growing season this year to be 0.75. What is the expected value of hiring teenagers?

A) $62,500
B) $52,500
C) $46,250
D) $12,990
E) Indeterminate.

Question 7

If the land owner is risk averse he would choose the action with the lowest Coefficient of Variation (CV). Which of the following is true?

A) The CV is lower for building townhouses and condominiums.
B) The CV is lower for building an active retirement community.
C) Even if the land owner is risk averse, the CV leads to the same choice as the expected value approach.
D) The CV is higher for building townhouses and condominiums, and even if the land owner is risk averse, the CV leads to the same choice as the expected value approach.
E) The CV is lower for building an active retirement community, and even if the land owner is risk averse, the CV leads to the same choice as the expected value approach.

Question 8

Suppose housing analysts predict that the probabilities for future mortgage interest rates going up, staying about the same, and going down are 0.35, 0.50 and 0.15, respectively. Compute the expected value for each action. Based on these results, which action should the land owner choose?

Question 9

Compute the Coefficient of Variation for each action. If the land owner is risk averse, would the CV for each action lead to the same choice as the expected value? Explain.

Question 10

Compute the Coefficient of Variation for each action. If the farm owner is risk averse, would the CV for each action lead to the same choice as the expected value? Explain.

Question 11

Compute the standard deviation for each action.

Question 12

Suppose the farmer's almanac predicts the probability of a good growing season this year to be 0.75. Compute the expected value for each action. Based on these results, which action should the farm owner choose?

Question 13

What is the expected value of perfect information?

Question 14

Consider the following to answer the question(s) below:
A land owner is considering a community development project. Even though he realizes that the current market for housing is not very favourable, he believes that there will be an influx of retirees into the area within the next five years. He is trying to decide between two alternatives: (1) building detached homes in a planned retirement community or (2) building a smaller townhouse/condominium complex. Mortgage interest rates will affect his outcomes and the applicable payoff (in $ millions) table is shown below.
Using the maximin approach, which action should the land owner choose?

Question 15

Consider the following to answer the question(s) below:
A land owner is considering a community development project. Even though he realizes that the current market for housing is not very favourable, he believes that there will be an influx of retirees into the area within the next five years. He is trying to decide between two alternatives: (1) building detached homes in a planned retirement community or (2) building a smaller townhouse/condominium complex. Mortgage interest rates will affect his outcomes and the applicable payoff (in $ millions) table is shown below.
According to the maximin approach, the land owner should

A) build the active retirement community if interest rates go down
B) build the active retirement community
C) build townhouses/condominiums if interest rates go down
D) build townhouses/condominiums
E) build either the active retirement community or townhouses/condominiums

Question 16

What is the expected value of perfect information?

Question 17

Consider the following to answer the question(s) below:
A land owner is considering a community development project. Even though he realizes that the current market for housing is not very favourable, he believes that there will be an influx of retirees into the area within the next five years. He is trying to decide between two alternatives: (1) building detached homes in a planned retirement community or (2) building a smaller townhouse/condominium complex. Mortgage interest rates will affect his outcomes and the applicable payoff (in $ millions) table is shown below.
Using the maximax approach, which action should the land owner choose?

Question 18

Consider the following to answer the question(s) below:
A land owner is considering a community development project. Even though he realizes that the current market for housing is not very favourable, he believes that there will be an influx of retirees into the area within the next five years. He is trying to decide between two alternatives: (1) building detached homes in a planned retirement community or (2) building a smaller townhouse/condominium complex. Mortgage interest rates will affect his outcomes and the applicable payoff (in $ millions) table is shown below.
Based on the expected value approach, the land owner should

A) build the active retirement community if interest rates go down
B) build the active retirement community
C) build townhouses/condominiums if interest rates go down
D) build townhouses/condominiums
E) build either the active retirement community or townhouses/condominiums

Question 19

Consider the following to answer the question(s) below:
A farm owner who grows summer vegetables (e.g. tomatoes) must decide whether to employ additional pickers this season. If he does, he could hire either migrant workers or local teenagers who need summer employment. The migrant workers are more experienced, faster, but more expensive. Although the teenagers will work for less, they are not as experienced and tend to damage plants and produce. His profits, taking into account losses from unpicked perished or damaged produce, depend on whether there is a good or bad growing season. The payoffs are shown in the table below.
Using the maximax approach, which action should the farm owner choose?

Question 20

Consider the following to answer the question(s) below:
A farm owner who grows summer vegetables (e.g. tomatoes) must decide whether to employ additional pickers this season. If he does, he could hire either migrant workers or local teenagers who need summer employment. The migrant workers are more experienced, faster, but more expensive. Although the teenagers will work for less, they are not as experienced and tend to damage plants and produce. His profits, taking into account losses from unpicked perished or damaged produce, depend on whether there is a good or bad growing season. The payoffs are shown in the table below.
According to the maximin approach, the farmer should

A) hire migrant workers if the growing season is good
B) hire teenagers
C) not do any extra hiring
D) hire migrant workers
E) not do any extra hiring if the growing season is good

Question 21

Consider the following to answer the question(s) below:
An investor has $10,000 to invest for one year. The choices for the placement of the funds include stocks, bonds, and mutual funds. The outcome of the investment however, will depend on the economic climate during the year. The table presents the payoffs in dollars for three possible economic scenarios. Forecasts suggest that the probability of a slowdown is 0.25, of no change is 0.50, and of growth is 0.25.
Action Economic Climate

According to the maximax approach, the investor would place his $10,000 in

A) stocks
B) bonds
C) mutual funds
D) stocks if there is economic growth
E) bonds if there is no change in economic climate

Question 22

The Return to Risk Ratio for bonds is

A) 8.4854
B) 70.71
C) 0.1055
D) 1.8935
E) 0.1179

Question 23

Consider the following to answer the question(s) below:
A group is planning a fundraising concert. They must decide whether to hold the event indoors or out. The weather, specifically, whether or not it rains that day, will affect the amount raised by the event. The payoff table is shown below:
Action Weather Conditions

According to the maximin approach, the group should

A) hold the concert indoors
B) hold the concert outdoors
C) hold the concert outdoors if it does not rain
D) hold the concert indoors if it rains
E) hold the concert indoors if it does not rain

Question 24

The standard deviation for an outdoor concert is

A) $18,000
B) $14,000
C) $2,000
D) $26,000
E) indeterminate

Question 25

Consider the following to answer the question(s) below:
A group is planning a fundraising concert. They must decide whether to hold the event indoors or out. The weather, specifically, whether or not it rains that day, will affect the amount raised by the event. The payoff table is shown below:
Action Weather Conditions

Historically the probability of rain on the day of the planned concert is 0.20. What is the expected value of an indoor concert?

A) $14,000
B) $26,000
C) $4,000
D) $2,000
E) $10,000

Question 26

Consider the following to answer the question(s) below:
A group is planning a fundraising concert. They must decide whether to hold the event indoors or out. The weather, specifically, whether or not it rains that day, will affect the amount raised by the event. The payoff table is shown below:
Action Weather Conditions

What is the expected value of perfect information?

A) $4,000
B) $30,000
C) $14,000
D) $26,000
E) $10,000

Question 27

If the farmer is risk averse, he would

A) hire migrant workers
B) hire teenagers
C) not do any extra hiring
D) make the same decision as he would using the expected value approach
E) give up farming

Question 28

If the group is risk averse, they should

A) plan to hold the event indoors
B) plan to hold the event outdoors
C) make the same decision as they would using the expected value approach
D) decide not to hold the event at all
E) plan to hold the event outdoors if it does not rain

Question 29

The expected value of perfect information is

A) $325
B) $400
C) $775
D) $925
E) $600

Question 30

The expected value with perfect information is

A) $925
B) $600
C) $525
D) $325
E) $150

Question 31

The standard deviation for hiring migrant workers is

A) $21,651
B) $12,990
C) $5,495
D) $2,500
E) $147

Question 32

Consider the following to answer the question(s) below:
An investor has $10,000 to invest for one year. The choices for the placement of the funds include stocks, bonds, and mutual funds. The outcome of the investment however, will depend on the economic climate during the year. The table presents the payoffs in dollars for three possible economic scenarios. Forecasts suggest that the probability of a slowdown is 0.25, of no change is 0.50, and of growth is 0.25.
Action Economic Climate

The expected value of mutual funds is

A) $525
B) $150
C) $600
D) $1,150
E) $925