Question 1

John is trying to decide whether to expand his business or not. If he continues his business as it is, with no expansion, there is a 50 percent chance his revenue will be $100,000 and a 50 percent chance his revenue will be $300,000. If he does expand, it will cost him $150,000, and there is a 30 percent chance his revenue will be $100,000; a 30 percent chance his revenue will be $300,000; and a 40 percent chance his revenue will be $500,000.John should expect that the value of his revenue will be ________ if he expands and ________ if he does not expand.

Accepted Answer

A) $320,000; $200,000 
B) $170,000; $50,000 
C) $120,000; $200,000 
D) −$30,000; $200,000

Question 2

People who exhibit risk-seeking behavior:

Accepted Answer

A) have a high willingness to take on situations with risk. 
B) have a low willingness to take on situations with risk. 
C) will only participate in high-risk situations. 
D) will always choose the riskier venture when given two choices.

Question 3

Consider two farmers, Samantha and William. Samantha grows sweet potatoes, which tend to do well during dry seasons. William grows watermelons, which tend to do better during rainy seasons. If the weather is dry this year, Samantha will earn $100,000 and William will earn $10,000. If the weather is rainy this year, Samantha will earn $30,000 and William will earn $120,000. There is a 50 percent chance of dry weather and a 50 percent chance of rainy weather this year.Suppose Samantha and William are considering merging their farms. If they do merge, they will split their profits equally. Which of the following statements is true?Samantha will prefer to merge, but William will prefer to keep his farm separate.The expected value of William's earnings if the farms merge is $65,000.The expected value of William's earnings if they do not merge is $65,000.

Accepted Answer

A) III only 
B) I and II only 
C) II and III only 
D) I, II, and III

Question 4

Bailey owns a farm, and her annual crop is dependent on the weather. If it has been an exceptionally rainy year, she can expect to earn $70,000. If it has been a very dry year, she will earn $20,000. If the weather is moderate, she will earn $50,000. There is a 20 percent chance that it will be a very rainy year; a 30 percent chance that it will be a very dry year; and a 50 percent chance that the weather will be moderate. What is the expected value of Bailey's earnings?

Accepted Answer

A) $50,000 
B) $25,000 
C) $45,000 
D) $60,000

Question 5

The interest rate you typically earn on a deposit at a bank:

Accepted Answer

A) represents the price of your loan. 
B) represents the risk of investing. 
C) is the opportunity cost to you of lending money. 
D) is the opportunity cost to a bank of lending money.

Question 6

Diversification involves investing all your money in:

Accepted Answer

A) one company. 
B) the same type of financial assets, with the same amount of risk. 
C) a variety of financial assets, with varying amounts of risk. 
D) None of these are true.

Question 7

The decision to buy a $100 _______ is complicated by the value of money changing over time.

Accepted Answer

A) concert ticket 
B) stock 
C) sweater 
D) blender

Question 8

Someone who is risk-averse is likely to:

Accepted Answer

A) buy a government bond instead of a stock. 
B) invest in a start-up company instead of putting money under the mattress. 
C) buy company stock instead of putting money in a savings account. 
D) All of these are true.

Question 9

Suppose Jack and Kate are at the town fair and are choosing which game to play. The first game has a bag with four marbles in it-1 red marble and 3 blue ones. The player draws one marble from the bag; if it is red, $20 is won, and if it is blue, $1 is won. The second game has a bag with 10 marbles in it-1 red, 4 blue, and 5 green. The player draws one marble from the bag; $20 is won if it is red, $5 is won if it is blue, and $1 is won if it is green. Both games cost $5 to play.If Kate decides to play the second game, what is the probability that she will pull out a green marble?

Accepted Answer

A) 10 percent 
B) 40 percent 
C) 50 percent 
D) 75 percent

Question 10

Different banks:

Accepted Answer

A) may offer loans at different rates. 
B) all offer loans at the same interest rate. 
C) are mandated to follow the interest rate set by the Fed. 
D) never offer loans at exactly the same rates.

Question 11

Suppose Jack and Kate are at the town fair and are choosing which game to play. The first game has a bag with four marbles in it-1 red marble and 3 blue ones. The player draws one marble from the bag; if it is red, $20 is won, and if it is blue, $1 is won. The second game has a bag with 10 marbles in it-1 red, 4 blue, and 5 green. The player draws one marble from the bag; $20 is won if it is red, $5 is won if it is blue, and $1 is won if it is green. Both games cost $5 to play.If Kate decides to play the second game, what is the expected value of her payoff?

Accepted Answer

A) $5.00 
B) $5.75 
C) $4.50 
D) $4.00

Question 12

Jude owns a house worth $250,000 in an area that is prone to tornadoes. Suppose there is a 5 percent chance during the next year that Jude's house will incur $50,000 of damage from a tornado and a 1 percent chance that his home will be completely destroyed by a tornado. What is the expected value of Jude's house next year?

Accepted Answer

A) $240,000 
B) $245,000 
C) $247,500 
D) $230,000

Question 13

Insurance companies:

Accepted Answer

A) profit from the difference between the premiums paid and the expected value of payouts. 
B) only profit by selling to risk neutral clients. 
C) must charge less than the expected value of payouts, otherwise they would go out of business. 
D) All of these are true.

Question 14

Present value is how much a certain amount of money:

Accepted Answer

A) that will be obtained in the future is worth today. 
B) that you currently have will be worth in the future. 
C) that is earning interest will be worth when you withdraw it. 
D) needs to be discounted to be meaningful.

Question 15

Which of the following statements about the decision to purchase insurance is true?

Accepted Answer

A) You will not be able to know which decision was the right one to make until you can use hindsight. 
B) The decision must be made in consideration of the best information available at the time. 
C) The cost of the insurance should be weighed against the benefit of payouts over the life of the contract. 
D) None of these are true.

Question 16

People who have a high willingness to take on situations with risk are considered to be:

Accepted Answer

A) risk-averse. 
B) risk-seeking. 
C) low-risk. 
D) high-compensation.

Question 17

Matty and Rudy are the same age, live in the same town, and hold similar jobs a similar distance from their respective homes. They are so similar, in fact, that they are both offered the same auto insurance options. However, Matty has never been a particularly good driver, so he buys high-coverage auto insurance. Rudy, on the other hand, takes pride in being an excellent driver and thus only carries the minimum amount of insurance required. This example illustrates the potential for:

Accepted Answer

A) risk pooling. 
B) risk aversion. 
C) adverse selection. 
D) diversification.

Question 18

Jackson owns a house worth $350,000 in an area that is prone to hurricanes. Suppose there is a 12 percent chance during the next year that Jackson's house will incur $25,000 of damage from a hurricane and a 2 percent chance that his home will be completely destroyed by a hurricane. Suppose an insurance company offers him a policy that fully reimburses him in the event that his home is damaged by a hurricane. The insurance company charges a $10,000 premium for this policy. Which of the following statements is true? If Jackson is risk averse, he will definitely buy the insurance. The expected value of Jackson's house if he purchases the insurance is $340,000. The expected value of Jackson's house if he does not purchase the insurance is $340,000.

Accepted Answer

A) II only 
B) I and III only 
C) III only 
D) I, II, and III

Question 19

John is trying to decide whether to expand his business or not. If he continues his business as it is, with no expansion, there is a 50 percent chance his revenue will be $100,000 and a 50 percent chance his revenue will be $300,000. If he does expand, it will cost him $150,000, and there is a 30 percent chance his revenue will be $100,000; a 30 percent chance his revenue will be $300,000; and a 40 percent chance his revenue will be $500,000.To make the best decision, John should compare:

Accepted Answer

A) the expected value of his revenue if he doesn't expand with the expected value of his revenue if he does expand. 
B) the difference in expected revenue if he does or does not expand to the cost of expansion. 
C) the expected value of his revenue if he expands to the cost of expansion. 
D) None of these are true.

Question 20

One can think of interest as:

Accepted Answer

A) the cost of inflation. 
B) the price of borrowing per dollar. 
C) the time it takes a bond to mature. 
D) All of these are true.

Exam 11: Time and Uncertainty