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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 he will earn $100,000 and a 50 percent chance he will earn $300,000.If he does expand,there is a 30 percent chance he will earn $100,000,a 30 percent chance he will earn $300,000 and a 40 percent chance he will earn $500,000.It will cost him $150,000 to expand.The difference in expected earnings if John chooses to expand versus not expand is:


A) $320,000.
B) $200,000.
C) $150,000.
D) $120,000.

E) B) and C)
F) A) and D)

Correct Answer

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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,they win $20 and if it is blue,they win $1.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; if it is red,they win $20; if it is blue,they win $5; and if it is green,they win $1.Both games cost $5 to play.Kate decides to play the second game.Her probability of pulling out a green marble is:


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

E) A) and B)
F) C) and D)

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Risk is:


A) when the costs or benefits of an event or choice are uncertain.
B) why the changing value of money is such a challenge.
C) to always be avoided, at any cost.
D) None of these statements is true.

E) C) and D)
F) B) and D)

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Risk diversification refers to the process by which:


A) people organize themselves in a group to collectively absorb the cost of the risk faced by each individual.
B) insurance companies change the risk aversion of their clients.
C) risks are shared across many different assets or people, reducing the impact of any particular risk on any one individual.
D) insurance companies reallocate the likelihood of catastrophes happening.

E) A) and B)
F) All of the above

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Risk aversion:


A) is the same for everyone.
B) is an unusual type of preference.
C) is an aspect of an individual's preferences.
D) All of these statements are true.

E) B) and C)
F) A) and D)

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If you knew that an investment was going to pay you $128 in 5 years,and you knew that the annual interest rate over that time would be 5 percent,you could calculate the present value to be:


A) $95.
B) $90.
C) $105.
D) None of these is true.

E) A) and D)
F) None of the above

Correct Answer

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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 he will earn $100,000 and a 50 percent chance he will earn $300,000.If he does expand,there is a 30 percent chance he will earn $100,000,a 30 percent chance he will earn $300,000 and a 40 percent chance he will earn $500,000.It will cost him $150,000 to expand.To make the best decision,John should compare:


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

E) B) and C)
F) A) and D)

Correct Answer

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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 he will earn $100,000 and a 50 percent chance he will earn $300,000.If he does expand,there is a 30 percent chance he will earn $100,000,a 30 percent chance he will earn $300,000 and a 40 percent chance he will earn $500,000.It will cost him $150,000 to expand.The expected value of John's earnings if he chooses to expand is:


A) $320,000
B) $230,000
C) $900,000
D) $140,000

E) None of the above
F) B) and D)

Correct Answer

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In terms of insurance,which of the following statements is explained by adverse selection?


A) A person with riskier characteristics tends to be more likely to buy insurance.
B) A person who is more risk-averse tends to be more likely to buy insurance.
C) Insurance companies charge risk-averse customers a higher premium, since they need more peace of mind.
D) None of these statements is true.

E) A) and B)
F) None of the above

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Economists believe that people are:


A) generally risk-seekers.
B) generally risk-averse.
C) always risk-averse.
D) always risk-seekers.

E) A) and B)
F) None of the above

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The amount of interest owed on a loan of $75,000 after a year at an interest rate of 1 percent is:


A) $7,500.
B) $75,750.
C) $82,500.
D) None of these is true.

E) B) and C)
F) A) and D)

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In making decisions about insurance,a crucial piece of information to know is:


A) how easily you can reduce the risk of experiencing the event you're insuring against.
B) how many others will likely be affected by the same risk.
C) how catastrophic would the event's occurrence be if the event you're insuring against happened.
D) when the event you're insuring against is most likely to occur.

E) None of the above
F) B) and C)

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The value of a loan of $50,000 after a year at 2 percent interest is:


A) $1,000.
B) $52,000.
C) $49,000.
D) None of these is true.

E) None of the above
F) A) and C)

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Insurance companies try to mitigate the problem of adverse selection by:


A) asking potential customers a seemingly endless list of questions to gain as much information as they can about the person's risk characteristics.
B) charging a higher premium to groups with similar ages or behaviors that correlate with risky behavior.
C) charge a higher price to all individuals to cover the lack of information.
D) All of these statements are true.

E) C) and D)
F) None of the above

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Compounding is:


A) the process of accumulation of additional interest paid on interest that has already been earned.
B) the process of adding the percentage of interest times your initial principal yearly.
C) the process of deposits steadily increasing a set amount annually.
D) None of these statements is true.

E) A) and B)
F) B) and C)

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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,they win $20 and if it is blue,they win $1.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; if it is red,they win $20; if it is blue,they win $5; and if it is green,they win $1.Both games cost $5 to play.If Jack only cares about expected value,and not risk,he should decide to play a game if:


A) the expected value of the payoff is higher than the price to play the game.
B) the expected value of the payoff is lower than the price to play the game.
C) the expected value of the payoff is higher than the expected value of the payoff in the other game.
D) the expected value of the payoff is double the price to play the game.

E) B) and C)
F) All of the above

Correct Answer

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If you knew that an investment was going to pay you $1,188,757 in 20 years,and you knew that the annual interest rate over that time would be 2 percent,you could calculate the present value to be:


A) $1,000,000.
B) $1,500,000.
C) $905,000.
D) $800,000.

E) B) and D)
F) B) and C)

Correct Answer

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Knowing how to translate between present and future value can be useful when:


A) the benefits and opportunity cost occur at different times.
B) there are benefits and costs occurring at the same time.
C) the current costs are higher than the present benefits.
D) there are no benefits and costs.

E) A) and D)
F) All of the above

Correct Answer

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Calculating expected value involves:


A) estimating how likely different outcomes are, and estimating the financial implications of each outcome.
B) predicting the most likely outcome and assuming that that event will occur.
C) assuming the worst outcome will occur and evaluating the financial implication of that outcome.
D) None of these statements is true.

E) None of the above
F) A) and B)

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Risk-seeking behavior:


A) is irrational.
B) is an aspect of an individual's preferences.
C) is the same for everyone.
D) All of these statements are true.

E) All of the above
F) B) and C)

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