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Exam 11: Time and Uncertainty

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Question 51

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Calculating expected value involves:

A) estimating how likely different outcomes are and what the financial implications of each outcome might be.
B) predicting the most likely outcome and planning for the event to occur.
C) assuming the worst outcome will occur and evaluating the financial implication of that outcome.
D) None of these are true.

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

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Question 52

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The two big problems facing insurance companies in trying to manage risk are:

A) risk pooling and diversification.
B) risk pooling and adverse selection.
C) adverse selection and moral hazard.
D) moral hazard and diversification.

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

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Question 53

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Which of the following entities can diversify risk?

What is expected value?

If insurance companies knew how risky their customers were:

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.What is the difference in expected earnings if John chooses to expand versus not expand?

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:

Using hindsight to judge whether buying insurance was a good idea or not:

When deciding whether or not to purchase insurance for an event, it is important to know:

A consequence of adverse selection for the insurance market is that:

Risk diversification refers to the process by which:

Rational people prefer to experience immediate benefits and delayed costs because:

Economists have observed that people are:

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.If John decides to expand based on expected value, it means that:

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 Jack cares only about expected value, and does not mind risk, he should decide to play the game in which the expected value of the payoff is:

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.Jack decides to play the first game and Kate decides to play the second game. The expected value of the payoff:

Compounding is the process of:

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. Suppose an insurance company offers him a policy that fully reimburses him in the event that his home is damaged by a tornado. The insurance company charges a $10,000 premium for this policy. Which of the following statements is true?The expected value of Jude's home when he buys insurance is higher than the expected value if he does not buy insurance.If Jude is risk neutral, he will prefer to not buy insurance.Economists would say it is irrational to purchase the insurance.

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.What is the expected value of John's revenue if he chooses not to expand?

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 Jack only cares about the expected value of the outcome and does not care about risk, he should _______ the first game because it costs _______ and the expected payoff is _______.