choose the correct answer:

1. Probability

a.is a number between 0 and 1, inclusive.

b.indicates how likely an outcome is to occur.

c.is larger the more likely the event is to occur.

d.all of the above.

e.only (a) and (b)

2. Expected value represents

a.the actual payment one expects to receive.

b.the average of all payments one would receive if one undertook the risky event many times.

c.the payment one receives if he or she makes the correct decision.

d.the payment that is most likely to occur.

e.none of the above.

3. Variance is a measure of ________ and the higher the variance, ________.

a.expected profit; the greater the profit.

b.expected profit; the greater the risk.

c.risk; the greater the risk.

d.standard deviation; greater the standard deviation.

e.risk; the lower the risk.

4.Expected utility is

a.the maximum utility that a person can get from a set of possible outcomes.

b.the probability-weighted mean of the utility gained from a set of possible outcomes.

c.negative for risk-averse people.

d.indeterminant for risk preferring people.

e.both (a) and (b).

5. People who always choose not to participate in fair games are called

a.risk seekers.

b.risk averse.

c.risk neutral.

d.risk insensitive.

e.broke.

6. A risk averse individual is offered a choice between getting $400 for sure and entering a gamble that promises a gain of $1000 with probability 0.25 and a gain of $300 with probability 0.75. Given this situation, he or she will

a.definitely take the gamble.

b.definitely not take the gamble.

c.definitely take the gamble if his or her income is high enough.

d.take an action that cannot be determined without specifying the individual's utility function.

e.none of the above.

7. Which of the following utility functions exhibits Constant Absolute Risk Aversion (CARA)?

a.u(x) = 0

b.u(x) = x

c.u(x) = x - 0.5x²

d.u(x) = ln(x)

e.u(x) = - exp(-)

8. Which of the following utility functions exhibits Constant Relative Risk Aversion (CRRA)?

a.u(x) = 0

b.u(x) = x

c.u(x) = x - 0.5x²

d.u(x) = ln(x)

e.u(x) = - exp(-)

9. Which of the following utility functions would indicate the most (relative) risk averse behavior? (Hint: the one that has the highest relative risk aversion coefficient)

a.u(x) = 0

b.u(x) = x

c.u(x) = x^0.5

d.u(x) = ln(x)

e.u(x) = - 1/

10. Which of the following helps to reduce risk?

a.purchasing insurance.

b.obtaining more information.

c.diversifying

d.all of the above.

e.none of the above.

11. If Stock A increases in value when Stock B decreases in value at the same time, they are

a.negatively correlated.

b.uncorrelated.

c.positively correlated.

d.in different industries.

e.profitable.

12. If two events are perfectly positively correlated, then

a.diversification is not necessary since there is no risk.

b.diversification eliminates all risk.

c.diversification increases expected profit.

d.diversification does not reduce risk at all.

e.diversification only cuts the risk in half.

13. If fair insurance is offered to a risk-averse person, she will

a.buy enough insurance to eliminate all risk.

b.not buy any insurance because it is overpriced.

c.not buy any insurance since the marginal utility of the amount of the payment is positive.

d.buy enough insurance to cover about half of the possible loss.

e.none of the above.