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92. A risk-averse person has
a.
a utility function whose slope gets flatter as wealth rises. This means they have increasing marginal utility of
wealth.
b.
a utility function whose slope gets flatter as wealth rises. This means they have diminishing marginal utility of
wealth.
c.
a utility function whose slope gets steeper as wealth rises. This means they have increasing marginal utility of
wealth.
d.
a utility function whose slope gets steeper as wealth rises. This means they have diminishing utility of wealth.
93. The idea of insurance
a.
would not appeal to a risk-averse person.
b.
is, other things the same, to reduce the probability of a fire, accident, or death.
c.
is to share risk.
d.
is to provide a sure thing, not a gamble.
94. Which of the following actions best illustrates adverse selection?
a.
A person purposely chooses bonds of corporations with high default risk because of the high returns.
b.
A person dislikes losing $400 more than he likes winning $400.
c.
After obtaining automobile insurance a person drives less carefully than before.
d.
A person intending to take up dangerous hobbies applies for life insurance.
95. Which of the following best illustrates diversification?
a.
A company that produces many different products decides to produce fewer.
b.
After selling stock, corporate management spends funds on projects with greater risks than shareholders had
anticipated.
c.
Instead of holding only the stocks of companies engaged in the banking business, a person decides to hold
stock in a number of different companies producing different goods and services.
d.
A person decides to purchase only stocks that have paid high dividends in the past.
96. As the number of stocks in a portfolio rises,
a.
both firm-specific risks and market risk fall.
b.
firm-specific risks fall; market risk does not.
c.
market risk falls; firm-specific risks do not.
d.
neither firm-specific risks nor market risk falls.
97. In general, as a person includes fewer stocks and more bonds in his portfolio,
a.
both risk and expected return rise.
b.
risk rises but expected return falls.
c.
risk falls, but expected return rises.
d.
both risk and expected return fall.
98. People who hold well-diversified portfolios of stocks have greatly reduced or eliminated
a.
firm-specific risk, and so they do not need to worry about their wealth decreasing as a result of recessions.
b.
market risk, and so they do not need to worry about their wealth decreasing as a result of recessions.
c.
firm-specific risk, but still they have reason to worry about their wealth decreasing as a result of recessions.
d.
market risk, but still they have reason to worry about their wealth decreasing as a result of recessions.
99. If Cara’s utility falls more by losing $600 than it rises by gaining $600, she has
a.
increasing marginal utility of wealth and is risk averse.
b.
increasing marginal utility of wealth but is not risk averse.
c.
decreasing marginal utility of wealth and is risk averse.
d.
decreasing marginal utility of wealth but is not risk averse.
100. Diversifying
a.
increases the standard deviation of the value of a portfolio indicating its risk has increased.
b.
increases the standard deviation of the value of a portfolio indicating its risk has decreased.
c.
decreases the standard deviation of the value of a portfolio indicating its risk has increased.
d.
decreases the standard deviation of the value of a portfolio indicating its risk has decreased.
101. A person who is risk averse might accept a 50% chance of losing $100 today in exchange for a 50% chance of
winning $125 in two years if the interest rate was
a.
9% but not 10%
b.
10% but not 11%
c.
11% but not 12%
d.
None of the above is correct; a risk averse person would not accept any of the above bets.
102. Suppose interest of 5% for two years can be earned on $1,000 saved today with no risk. What is the least amount a
person would need to have a 50% chance of winning to be willing to face a 50% chance of losing $1,000 today and be
considered risk averse?
a.
$907.03 to be paid in two years
b.
$1,000.01 to be paid in two years
c.
$1,100.01 to be paid in two years
d.
$1,102.51 to be paid in two years
103. By holding insurance a person
a.
reduces the risk of a bad outcome, such as their house burning down.
b.
shares risk and so reduces the burden of risk.
c.
Both A and B are correct.
d.
Neither A nor B are correct.
104. Consider the following two situations. Irene accepts a job where she will be driving in dangerous traffic, so she seeks
auto insurance. After Victor buys health insurance, he visits the gym less frequently. Which of these person’s actions
illustrates moral hazard?
a.
both Irene’s and Victor’s
b.
Irene’s but not Victor’s
c.
Victor’s but not Irene’s
d.
neither Victor’s nor Irene’s
105. Which of the following make(s) insurance premiums higher than otherwise?
a.
adverse selection and moral hazard
b.
adverse selection, but not moral hazard
c.
moral hazard, but not adverse selection
d.
neither adverse selection nor moral hazard
106. A bank might make mortgages to people in different regions of the country. By doing so
a.
the bank reduces the risk it faces from falling house prices in its region and falling prices in all regions.
b.
the bank reduces the risk it faces of falling house prices in its region but not from falling prices in all regions.
c.
the bank reduces the risk it faces of falling house prices in all regions, but not the risk it faces from falling
house prices in its regions.
d.
the bank reduces neither the risk it faces from falling house prices in its region nor falling prices in all regions.
107. Samantha holds stocks in four companies. If she adds stocks of several more companies she will decrease
a.
firm specific risk and market risk.
b.
firm specific risk but not market risk.
c.
market risk but not firm specific risk.
d.
neither firm specific nor market risk.
108. Suppose that Albert can buy a bond for $1,000 that matures in two years and pays Albert $1,102.5 with certainty. He
is indifferent between this bond and one that has some risk but on which the interest rate is 3% higher. How much, to the
nearest penny, does the riskier bond pay in two years?
a.
$1,160.00
b.
$1,166.40
c.
$1,168.65
d.
$1,169.64
109. By diversifying, the risk of holding stock
a.
can be eliminated. On average over the past two centuries stocks paid a higher average real return than bonds.
b.
can be eliminated. On average over the past two centuries stocks paid a lower average real return than bonds.
c.
can be reduced but not eliminated. On average over the past two centuries stocks paid a higher average real
return than bonds.
d.
can be reduced but not eliminated. On average over the past two centuries stocks paid a lower average real
return than bonds.
110. If a stock or bond is risky
a.
risk averse people may be willing to hold it as part of a diversified portfolio.
b.
risk averse people may be willing to hold it if the expected return is high enough.
c.
both A and B are correct.
d.
risk averse people will not hold it.
111. From the standpoint of the economy as a whole, the role of
a.
the interest rate is to make sure that the price of bonds increases over time.
b.
diversification is to eliminate market risk.
c.
insurance is to reduce the risks inherent in life.
d.
insurance is to spread risks around more efficiently.
112. Which of the following statements is correct?
a.
A high-risk person is more likely to apply for insurance than a low-risk person because a high-risk person
would benefit more from insurance protection.
b.
A low-risk person is more likely to apply for insurance than a high-risk person because a low-risk person
would benefit more from insurance protection.
c.
Insurance companies can fully guard against the problem of adverse selection, but they cannot fully guard
against the problem of moral hazard.
d.
Insurance companies can fully guard against the problem of moral hazard, but they cannot fully guard against
the problem of adverse selection.
113. Kayla faces risks and she pays a fee to ABC Company; in return, ABC Company agrees to accept some or all of
Kayla’s risks. ABC Company is
a.
a mutual fund.
b.
an insurance company.
c.
a diversified company.
d.
an equity-financed company.
114. Lori, who currently owns stock in four companies, has decided to expand her portfolio by purchasing stock in
virtually every company that sells stock. In doing so, Lori will
a.
increase the risk of her portfolio.
b.
decrease some, but not all, of the risk of her portfolio.
c.
decrease all of the risk of her portfolio.
d.
leave the risk of her portfolio unchanged from its present level.
115. Which of the following pairs of portfolios exemplifies the risk-return tradeoff?
a.
For Portfolio A, the average return is 6 percent and the standard deviation is 15 percent; for Portfolio B, the
average return is 6 percent and the standard deviation is 25 percent.
b.
For Portfolio A, the average return is 5 percent and the standard deviation is 15 percent; for Portfolio B, the
average return is 8 percent and the standard deviation is 15 percent.
c.
For Portfolio A, the average return is 5 percent and the standard deviation is 25 percent; for Portfolio B, the
average return is 8 percent and the standard deviation is 15 percent.
d.
For Portfolio A, the average return is 5 percent and the standard deviation is 15 percent; for Portfolio B, the
average return is 8 percent and the standard deviation is 25 percent.
116. The risk of a portfolio
a.
increases as the number of stocks in the portfolio increases.
b.
is usually measured using a statistic called the standard diversification.
c.
is positively related to the average return of the portfolio.
d.
bears no relationship to the average return of the portfolio.
117. Stockholders of ComfortAir Corporation, an air conditioner and furnace manufacturer, are concerned that the
companies executives may take on greater risks than stockholders desire. This example illustrates
a.
moral hazard and market risk.
b.
moral hazard and firm specific risk.
c.
adverse selection and market risk.
d.
adverse selection and firm specific risk.
118. John has been a sky diver for many years. When the company John works for offers its employees the option to
purchase a life insurance policy, John purchases a policy. This illustrates the problem of
a.
moral hazard.
b.
adverse selection.
c.
risk-return tradeoff.
d.
diversification.
119. Suppose that John can buy a savings bond for $500 that matures in ten years and pays John $1,000 with certainty. He
is indifferent between this bond and another $500 bond that has some risk but on which the interest rate is 5% higher.
How much, to the nearest penny, does the riskier bond pay in ten years?
a.
$1,275.91
b.
$1,422.63
c.
$1,577.69
d.
$1,631.17
120. David recently received an inheritance, and he is planning to invest the inheritance in one of four stock portfolios.
Which of these portfolios would you expect to have the highest risk?
a.
A portfolio with an average annual rate of return of 5%.
b.
A portfolio with an average annual rate of return of 8%.
c.
A portfolio with an average annual rate of return of 10%.
d.
A portfolio with an average annual rate of return of 14%.
121. David recently received an inheritance, and he is planning to invest the inheritance in one of four stock portfolios.
Which of these portfolios would you expect to have the lowest risk?
a.
A portfolio with an average annual rate of return of 5%.
b.
A portfolio with an average annual rate of return of 8%.
c.
A portfolio with an average annual rate of return of 10%.
d.
A portfolio with an average annual rate of return of 14%.
122. Susan is planning to invest in one of four stock portfolios, and her financial advisor has given her details regarding
the risk associated with each portfolio. Which of the following portfolios would you expect to have the highest average
annual rate of return?
a.
A portfolio with a standard deviation of 3%.
b.
A portfolio with a standard deviation of 6%.
c.
A portfolio with a standard deviation of 9%.
d.
A portfolio with a standard deviation of 12%.
123. Susan is planning to invest in one of four stock portfolios, and her financial advisor has given her details regarding
the risk associated with each portfolio. Which of the following portfolios would you expect to have the lowest average
annual rate of return?
a.
A portfolio with a standard deviation of 3%.
b.
A portfolio with a standard deviation of 6%.
c.
A portfolio with a standard deviation of 9%.
d.
A portfolio with a standard deviation of 12%.
