Question 1

Use the following information for questions 
There are three types of cars, the good G, the bad B, and the ugly U.A G car is worth $30, a B car is worth $15, and a U car is worth $0.A buyer cannot distinguish the quality of cars offered for sale, but the seller does.If there is equal probability of a car being G, B, or U,
-which car is offered for sale in equilibrium and at what price?

Accepted Answer

A) B and U, at a price = $15. 
B) U only, at a price = $15. 
C) U only, at a price = $0. 
D) All cars will be offered for sale, at a price = $30. 
E) No cars will be offered for sale.

Question 2

Use the following information for questions .
There are two possible states of nature, s = 1, and s = 2, over the next period.There are two securities i and j) whose current prices are $10 and $15, respectively.Security i has a payoff of $10 in state s = 1, and $16 in state s = 2, while security j provides $25 in state s = 1 and $8 in state s = 2.
-What are the prices of the Arrow-Debreu securities in the two states?

Accepted Answer

A) 0.25 in state s = 1 and 0.675 in state s = 2. 
B) 0.3 in state s = 1 and 0.6 in state s = 2. 
C) 0.4 in state s = 1 and 0.75 in state s = 2. 
D) 0.5 in state s = 1 and 0.3125 in state s = 2. 
E) insufficient information.

Question 3

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Consider a firm with $100 retained earnings.It has risky debt outstanding which requires a payment of $100 one period hence.The firm has a risky project which requires an investment of $50 today.If the project is undertaken, the shareholders get a liquidating dividend of $50 today.The state of nature one period hence is either High H or Low L with equal probability.If no investment is made today, the firm has a total value of $120 in state H or $80 in state L.If the investment is made, the firm's total value is $250 in state H or $10 in state L.Assume a discount rate of zero.
-The firm's expected total value with the investment is

Accepted Answer

A) $250 
B) $200 
C) $180 
D) $110 
E) $100

Question 4

Which of the following statements is are true?

Accepted Answer

A) A risk-preferring individual always prefers the riskier of two gambles that involve different expected value. 
B) A risk neutral individual is indifferent between receiving with certainty the expected value of a gamble and the uncertainty of the gamble itself. 
C) A risk neutral individual has a utility function which is linear in wealth. 
D) Both a and b. 
E) Both b and c.

Question 5

Use the following information for questions 
Consider a firm with $100 retained earnings.It has risky debt outstanding which requires a payment of $100 one period hence.The firm has a risky project which requires an investment of $50 today.If the project is undertaken, the shareholders get a liquidating dividend of $50 today.The state of nature one period hence is either High H or Low L with equal probability.If no investment is made today, the firm has a total value of $120 in state H or $80 in state L.If the investment is made, the firm's total value is $250 in state H or $10 in state L.Assume a discount rate of zero.
-What is the expected payoff to the bondholders if the project is ndertaken?

Accepted Answer

A) $85 
B) $55 
C) $30 
D) -$30 
E) -$55

Question 6

If the role of financial intermediaries is to produce and process information, then they are least needed when

Accepted Answer

A) the capital market is weak-form efficient. 
B) the capital market is semi strong-form efficient. 
C) the capital market is strong-form efficient. 
D) information is costly for individuals to obtain and process. 
E) none of the above.

Question 7

With a dissipative signal,

Accepted Answer

A) there is no social deadweight loss in the aggregate 
B) the receiver compensates the sender for the cost of the signal 
C) the incentive compatibility condition will always be restored 
D) the sender absorbs some of the cost of signaling 
E) all of the above

Question 8

A market is considered complete if

Accepted Answer

A) there are more number of states of nature than there are securities 
B) there are fewer number of states of nature than there are securities 
C) there are as many securities as there are states of nature 
D) it is frictionless 
E) both b and d.

Question 9

Use the following information for questions 
Suppose you are a bank lending officer and you are trying to determine if it is worthwhile giving a loan to a potential borrower.You have a prior belief that a borrower is good or bad with equal probability.By gathering information you can determine, albeit imperfectly, whether an applicant is good or bad.If the applicant is good, there is a probability of 0.7 0.3 that your signal reveals that he is good bad.If the applicant is bad, there is a 0.4 0.6 probability that your signal reveals that he is good bad.
-What is your posterior belief that an applicant is good when your signal tell you that he is good?

Accepted Answer

A) 0.36 
B) 0.55 
C) 0.64 
D) 0.70 
E) Insufficient information

Question 10

Use the following information for questions .
There are two possible states of nature, s = 1, and s = 2, over the next period.There are two securities i and j) whose current prices are $10 and $15, respectively.Security i has a payoff of $10 in state s = 1, and $16 in state s = 2, while security j provides $25 in state s = 1 and $8 in state s = 2.
-If you want to get a payoff of $16 in state s = 1 and $12.8 in state s = 2, how would you allocate your wealth between the two securities i and j?

Accepted Answer

A) 10% in I and 80% in J 
B) 10% in J and 90% in J 
C) 80% in I and 20% in J 
D) 70% in I and 20% in J 
E) 60% in I and 40% in J

Question 11

Moral hazard is a situation where

Accepted Answer

A) a self-interested agent has an attribute that is unknown to the principal prior to contracting 
B) the principal undertakes an action at the expense of the agent 
C) a self-interested agent undertakes an unobservable action at the expense of the principal and the outcome of that action contains some noise 
D) both a and b 
E) both b and c

Question 12

Use the following information for questions 
There are three types of cars, the good G, the bad B, and the ugly U.A G car is worth $40, a B car is worth $20, and a U car is worth $15.The seller knows the precise quality of his car, but the buyer cannot distinguish the difference in the quality of a car offered for sale.There is an equal probability of a car being G, B, or U.
-Suppose the seller of type G offers a warranty of $g, the type B seller offers $b, and the type U seller offers $u if the car fails.The probability of failure is 0.1, 0.6, and 0.9 for the G, B, and U types, respectively.An incentive compatibility condition is

Accepted Answer

A) $40 - 0.4$g ≤ $20 and $20 - 0.6$b ≤ $15 
B) $40 - 0.5$b ≤ $20 and $20 - 0.6$u ≤ $15 
C) $40 - 0.5$g ≤ $20 and $20 - $u ≤ $15 
D) $40 - 0.6$g ≤ $20 and $20 - 0.9$b ≤ $15 
E) $40 - 0.5$g≤ $20 and $20 - 0.3$b ≤ $15

Question 13

Suppose there are two risky assets, X and Y, and a riskless bond, B.There are two possible states H and L of the economy over the next period.X provides a payoff of $0 in state H and $50 in state L, while Y provides a payoff of $50 in state H and $0 in state L.B provides a payoff of $50 regardless of the states.X, Y, and B are currently selling for $30, $30, and $25, respectively.A possible riskless arbitrage opportunity is to...

Accepted Answer

A) buy one unit each of X and Y and sell one unit of B to get a riskless profit of $35 
B) buy one unit of B and sell one unit each of X and Y to get a riskless profit of $35 
C) buy one unit each of X and B and sell one unit of Y to get a riskless profit of $25 
D) buy one unit each of Y and B and sell one unit of X to get a riskless profit of $25 
E) there is no riskless arbitrage opportunity.

Question 14

Use the following information for questions 
There are three types of cars, the good G, the bad B, and the ugly U.A G car is worth $40, a B car is worth $20, and a U car is worth $15.The seller knows the precise quality of his car, but the buyer cannot distinguish the difference in the quality of a car offered for sale.There is an equal probability of a car being G, B, or U.
-In equilibrium, which car is offered for sale and at what price?

Accepted Answer

A) B and U, at a price = $25 
B) U only, at a price = $17.5 
C) U only, at a price = $15 
D) U only, at a price = $0 
E) No car will be offered for sale since the rational expectations price is $0

Question 15

There are two assets, A and B, with a standard deviation of 10 and 15, respectively.If the correlation coefficient between the two assets is 0.5, then a portfolio that consists of 0.4 of A and 0.6 of B has a standard deviation of

Accepted Answer

A) 11.53 
B) 13.00 
C) 15.00 
D) 18.02 
E) 20.00

Question 16

Use the following information for questions 
Consider a firm with $100 retained earnings.It has risky debt outstanding which requires a payment of $100 one period hence.The firm has a risky project which requires an investment of $50 today.If the project is undertaken, the shareholders get a liquidating dividend of $50 today.The state of nature one period hence is either High H or Low L with equal probability.If no investment is made today, the firm has a total value of $120 in state H or $80 in state L.If the investment is made, the firm's total value is $250 in state H or $10 in state L.Assume a discount rate of zero.
-To maximize the shareholders' wealth, the firm should

Accepted Answer

A) Reject the project since it has a value = -$40 to the shareholders 
B) Reject the project since it has a value = -$15 to the shareholders 
C) Accept the project since it has a value = $110 to the shareholders 
D) Accept the project since it has a value = $125 to the shareholders 
E) Indifferent since the project has a zero net present value

Exam 1: Basic Concepts