Test Bank Risk And Uncertainty Chapter 9

Chapter 9 Multiple Choice Questions

1. Risk occurs when

a. there is a known probability of random variance in the outcome of an action

b. there is imperfect information about the outcome of an action

c. we are uncertain about a given probability

d. there are known knowns, known unknowns, and unknown unknowns

2. Suppose you play a game where you pay $100 dollars to participate and have a 50% chance of winning nothing, a 10% chance of winning $1,100, a 20% chance of winning $600 and a 25% chance of losing $650. What is the expected value of participating in the game?

a. $100

b. $0

c. -$100

d. $1,050

3. A fair gamble is

a. a risk where the participant can expect to win any amount greater than 0

b. a risk where all possible outcomes are known to the participant

c. a risk where the player has a 50% chance of winning and a 50% chance of losing

d. a risky decision with an expected value of $0

4. You flip a coin and roll a di simultaneously. If the coin is heads up you win as many dollars as there are on the face of di. If the coin is tails, you must pay $3. You have the option to play or not. What should you do if you are a risk neutral person?

a. play

b. not play

c. it doesn’t matter, the expected value is the same

[Figures 9-6 and 9-7] labeled as Figure 1 and Figure 2

5. Which of the above figures is the utility function for a risk-averse person

a. Figure 1

b. Figure 2

c. select this to automatically receive half credit for this question

6. Suppose a person has a risk averse utility function of U(W)= √(Wealth). Also, suppose her initial wealth is $2,500. She can choose to play a game with a 50% chance of winning $1,100 and a 50% chance of losing $900. Would she choose to play the game ?

a. yes

b. no

c. she will be indifferent between playing and not playing

7. Suppose a person has a 1/100 chance of being mugged on the street. His utility function is √(Wealth). He initially has $1,600 which he carries on him at all times. If he’s mugged he loses all of his money. What is the maximum he would be willing to pay to insure his money against mugging?

a. $40.13

b. $16

c. $25.67

d. $34.84

8. Option value is the

a. most a person will pay for a risky product before knowing what the outcome will be

b. difference between the option price and the expected value

c. net benefits of every possible policy action weighted by the odds of that outcome

d. the value a person chooses to attribute to a good

[Show figure 9.9]

9. Which line shows a risk free asset in the capital asset pricing model?

a. β=1

b. β<1

c. β>1

d. none of the above

10. According to the Capital Asset Pricing Formula, if the risk free rate is 3%, the market rate of return is 6%, and Beta = .6, what is the required rate of return on the asset?

a.4.8%

b.6%

c.3.6%

d.3%

11. Community rating and adverse selection are somewhat related concepts in insurance policy analysis. Which of the following are true regarding adverse selection:

a. given equal insurance premiums across groups, the most costly households will tend to buy insurance, while the least costly households will not.

b. adverse selection limits rate differences to selected categories, which does not allow insurance companies to charge each group according to its expected cost.

c. only the sickest or most dangerous are likely to buy insurance.

d. adverse selection refers to bad choices among some individuals.

e. a and c are both correct.

12. Quasi option value is the maximum a person would pay for new information that reduces

a. risk

b. probability of losing any money

c. uncertainty

d. expected value