BUS404-FinalExam-Answers

If A is less risk-adverse than B, then which of the following statements is true?

Choose one answer.

	a. For the same risk, A requires a higher return than B.
	b. For the same return, B tolerates a higher risk than A.
	c. For the same return, A tolerates a higher risk than B.
	d. For the same risk, B requires a higher return than A.

Question 2

Perils refer to which of the following?

Choose one answer.

	a. Conditions that increase the cause of losses
	b. The cause of loss
	c. Ways to reduce risks
	d. Negligent behaviors, dishonesty, or activities that border on criminality

Question 3

Proper diversification will reduce which of the following types of risk?

Choose one answer.

	a. Total risk
	b. Systematic risk
	c. Unsystematic risk
	d. Portfolio risk

Question 4

What are moral hazards?

Choose one answer.

	a. Moral hazards refer to conditions that increase the cause of losses.
	b. Moral hazards refer to situations where people take undue risks, because they do not have to bear the consequences.
	c. Moral hazards refer to conditions that decrease the cause of losses.
	d. Moral hazards involve attitudes of carelessness and lack of concern.

Question 5

What is hedging?

Choose one answer.

	a. Hedging refers to activities aimed to reduce or eliminate risk.
	b. Hedging prevents losses due to earthquake.
	c. Hedging prevents competition from foreign companies.
	d. Hedging increases expected profits.

Question 6

Which of the following best describes a risk-averse person?

Choose one answer.

	a. A risk-averse person is uncomfortable with uncertainty and always wants to reduce risk.
	b. A risk-averse person will pursue investments with high uncertainty and volatility in exchange for anticipated higher returns.
	c. A risk-averse person is most concerned about the expected return.
	d. None of the above

Question 7

Which of the following is a possible example of a non-insurable peril?

Choose one answer.

	a. Nuclear power plant liability
	b. Employee strikes
	c. Theft
	d. Hurricanes

Question 8

Which of the following is consistent with risk-averting behavior, when choosing between two investment strategies with the same expected profit?

Choose one answer.

	a. Select the strategy with the larger coefficient of variation.
	b. Select the strategy with maximum possible return.
	c. Select the strategy with the smallest standard deviation.
	d. All of the above

Question 9

Which of the following is NOT a speculative risk?

Choose one answer.

	a. Public relation risk
	b. Investment risk
	c. Fire risk
	d. Foreign exchange risk

Question 10

Which of the following is NOT an insurable natural peril?

Choose one answer.

	a. Disease risks
	b. Windstorm
	c. Terrorism
	d. Lightning

Question 11

Which of the following is NOT pure risk?

Choose one answer.

	a. Fire risk
	b. Investment risk
	c. Flood risk
	d. Earthquake risk

Question 12

Which of the following is true about the principal-agent problem?

Choose one answer.

	a. The principal-agent problem is a type of moral hazard.
	b. The principal-agent problem arises when the principal and the agent have different objectives.
	c. The principal-agent problem arises when the contract with the agent cannot be enforced.
	d. All of the above

Question 13

Which of the following risks is NOT diversifiable?

Choose one answer.

	a. Legal risk
	b. Operational risk
	c. Inflation risk
	d. Credit risk

Question 14

Which of the following statements is false?

Choose one answer.

	a. When there is only one possible outcome to a decision, there is no risk.
	b. Probability distribution refers to the probabilities of all possible states or outcomes.
	c. If the probability of a company that will fail is 0.8, then the probability that the company will succeed is 0.2.
	d. The expected profit of a strategy is equal to the profit realized from the outcome with the highest level of probability.

Question 15

A market index fund has a beta equal to which of the following?

Choose one answer.

	a. 1
	b. 1.5
	c. 0.5
	d. 0

Question 16

A portfolio consists of two equally-weighted stocks with standard deviations of 20% and 15%, respectively. The covariance between the two stocks is 138. Calculate the standard deviation of the portfolio.

Choose one answer.

	a. 25%
	b. 35%
	c. 5%
	d. 15%

Question 17

A risk free security has a beta equal to which of the following?

Choose one answer.

	a. 1
	b. 1.5
	c. 0.5
	d. 0

Question 18

Calculate the beta of stock XYZ if the risk-free rate is 3%, if the expected return of the stock is 13.4%, and if the rate of return of the market portfolio is 11%.

Choose one answer.

	a. 1.8
	b. 0.7
	c. 1.3
	d. 0.2

Question 19

Calculate the expected return of a portfolio consisting of assets A and B. Asset A accounts for two-third of the portfolio values. The expected returns of A and B are 10% and 5%, respectively.

Choose one answer.

	a. 7.5%
	b. 8.4%
	c. 15%
	d. 9.3%

Question 20

Calculate the standard deviation of a portfolio that has a 20% chance of returning 7%, a 30% chance of returning 8%, a 25% chance of returning 10%, and a 25% chance of returning 12%.

Choose one answer.

	a. 1.9%
	b. 5.7%
	c. 7.3%
	d. 0.9%

Question 21

Complete the following statement. Beta is a measure of:

Choose one answer.

	a. systematic risk.
	b. unsystematic risk.
	c. inflation risk.
	d. variance of returns.

Question 22

Complete the following statement. The effects of diversification for a portfolio increase if:

Choose one answer.

	a. the number of stocks decrease
	b. the correlation between the stocks in the portfolio decreases
	c. the correlation between the stocks in the portfolio increases
	d. the number of stocks stays the same

Question 23

If you decrease the number of stock in a portfolio from 100 to 5, you will likely increase which of the following?

Choose one answer.

	a. The nonsystematic risk of the portfolio
	b. The systematic risk of the portfolio
	c. The return of the portfolio
	d. The risk of the portfolio

Question 24

Inflation is an example of which of the following?

Choose one answer.

	a. Systematic risk
	b. Unsystematic risk
	c. Total risk
	d. Diversifiable risk

Question 25

Relative risk of an investment proposal can be measured by which of the following?

Choose one answer.

	a. The coefficient of variation of net present value
	b. The expected value of net present value
	c. The standard variation of net present value
	d. The likelihood of maximum gain

Question 26

The beta of a company may fluctuate due to which of the following?

Choose one answer.

	a. Changes in the company’s leverage
	b. Changes in competition
	c. Changes in the relative relationship to the market
	d. All of the above

Question 27

The calculation of variance a portfolio DOES NOT require which of the following?

Choose one answer.

	a. The expected returns of the assets in the portfolio
	b. The variances of the assets in the portfolio
	c. The proportions of the assets in the portfolio
	d. The correlations between of the assets in the portfolio

Question 28

The variance of portfolio returns does not depend on the following

Choose one answer.

	a. The weight of each asset in the portfolio
	b. The variance of the returns of each individual asset.
	c. The expected return of each asset.
	d. The covariance among the returns of assets in the portfolio.

Question 29

Two stocks have a correlation coefficient of -0.9. What does this indicate?

Choose one answer.

	a. They move in opposite directions.
	b. They are independent of each other.
	c. They move in the same direction.
	d. They have similar standard deviations.

Question 30

Two stocks have a correlation coefficient of 0.9. What does this indicate?

Choose one answer.

	a. They move in opposite directions.
	b. They are independent of each other.
	c. They move in the same direction.
	d. They have similar standard deviations.

Question 31

What is the interest rate risk of a loan?

Choose one answer.

	a. The risk that the firm that will default on payment of interest or principal of the loan or bond
	b. The risk that the value of the loan will decline due to an increase in interest rates
	c. The risk that the value of the loan will decline due to the decline in the aggregate value of all assets in the economy
	d. All of the above

Question 32

Which of the following industries is most likely to have a low beta?

Choose one answer.

	a. The financial industry
	b. The high tech industry
	c. The utilities industry
	d. The construction industry

Question 33

Which of the following measures risk per unit of expected return?

Choose one answer.

	a. Beta
	b. Variance
	c. Coefficient of variation
	d. Correlation coefficient

Question 34

Which of the following statement accurately describes the credit risk of a loan?

Choose one answer.

	a. The risk that the firm that will default on payment of interest or principal of the loan or bond
	b. The risk that the value of the loan will decline due to an increase in interest rates
	c. The risk that the value of the loan will decline due to the decline in the aggregate value of all assets in the economy
	d. All of the above

Question 35

Which of the following statement is not true?

Choose one answer.

	a. The variance of an individual investment only captures unsystematic risk.
	b. An efficient portfolio is a portfolio that falls on the investor’s risk preference function, which describes the investor’s trade-off between risk and return.
	c. Systematic risk cannot be diversified away.
	d. Unsystematic risk can be eliminated by having a balanced portfolio.

Question 36

Which of the following statements about covariances between assets is true?

Choose one answer.

	a. Covariances between assets can only be negative.
	b. Covariances between assets can only be positive.
	c. Covariances quantify the dependency between two assets.
	d. Covariances between assets do not change over time.

Question 37

Which of the following statements about the coefficient of variation is true?

Choose one answer.

	a. The coefficient of variation allows you to determine how much risk that you are assuming in comparison to expected payoff.
	b. The coefficient of variation measures diversification in your portfolio.
	c. The coefficient of variation is inversely proportional with standard deviation.
	d. All of the above

Question 38

Which of the following statements is true?

Choose one answer.

	a. The beta coefficient indicates how volatile a stock is relative to the market.
	b. Systematic risk measures risk that is related to the market.
	c. Unsystematic risk may be eliminated by selecting stocks that are not perfectly correlated.
	d. All of the above

Question 39

You allocate 40% of your 401k to a market index fund and 60% to a company XYZ stock with beta of 1.5. What is the beta for your 401 k portfolio?

Choose one answer.

	a. 0.9
	b. 1.5
	c. 1.3
	d. 0.8

Question 40

You are asked to construct a riskless portfolio using two risky stocks. What would be the correlation coefficient between these two stocks?

Choose one answer.

	a. -1.0
	b. -0.5
	c. 0
	d. 1.0

Question 41

A risk adverse person chooses a strategy that yields which of the following?

Choose one answer.

	a. The highest expected payoff
	b. The lowest expected payoff
	c. The highest expected utility
	d. The lowest standard deviation

Question 42

An investor’s portfolio should be designed to maximize which of the following?

Choose one answer.

	a. Expected return utility
	b. Expected profit
	c. Risk
	d. All of the above

Question 43

Complete the following sentence. For a risk averter, the marginal utility of money:

Choose one answer.

	a. increases.
	b. is zero.
	c. decreases.
	d. cannot be determined.

Question 44

Complete the following statement. If an investor gives recent information more weight than prior beliefs, she would make:

Choose one answer.

	a. a selection bias.
	b. a forecasting error.
	c. a framing effect.
	d. an adverse selection.

Question 45

In utility theory, what is the framing effect?

Choose one answer.

	a. A mathematical formulation that seeks to explain observed behavior without making any assumption about preferences
	b. The coding of alternatives that makes individuals vary from E(U) maximizing behavior
	c. A tendency to assign more weight to the state of the world that we have experienced and less to others
	d. All of the above

Question 46

Rational behavior seeks to maximize which of the following?

Choose one answer.

	a. Total utility
	b. Risk
	c. Profit
	d. Stability

Question 47

The utility theory quantifies which of the following?

Choose one answer.

	a. Risk of investment
	b. Sunk cost
	c. Individuals’ preferences and behaviors
	d. Expected payoff

Question 48

When does information asymmetry occur?

Choose one answer.

	a. When actions of the agent (manager) cannot be observed by the principal (owner)
	b. When one party knows more than the other party in the contract
	c. When a person with higher risk chooses to hedge the risk, preferably without paying more for the greater risk
	d. None of the above

Question 49

When making decisions under uncertainty, availability bias refers to which of the following?

Choose one answer.

	a. Tendency to base subjective assessments based on outcomes of an initial estimate
	b. Tendency to assign more weight to the state of the world that we have experienced and less to others
	c. Tendency to only use whatever information is easily availability
	d. Tendency to ignore sunk costs

Question 50

Which of the following best describes a risk premium?

Choose one answer.

	a. A risk premium reflects the riskiness of future profits.
	b. A risk premium is used with the discount rate to calculate present value.
	c. A risk premium is the cost of insurance.
	d. A risk premium is the cost of risk.

Question 51

A cash flow analysis does which of the following?

Choose one answer.

	a. It provides alternative financial action to undertake for each frequency/severity combination.
	b. It looks at the amount of cash that will be saved and brings it into today’s present value.
	c. It provides risk managers with the ability to slice and dice the data.
	d. None of the above

Question 52

A risk retention group does which of the following?

Choose one answer.

	a. A risk retention group provides risk management and retention to companies that are too small to act on their own.
	b. A risk retention group works to prevent losses.
	c. A risk retention group must assess the importance of the insurer’s claims adjusting and other services including underwriting when evaluating whether to create or rent a captive.
	d. A risk retention group provides risk management protection to its parent company and other affiliated organizations.

Question 53

Capital budgeting analysis is used to evaluate which of the following?

Choose one answer.

	a. Accounting income
	b. Operating profit
	c. Cash flow
	d. Risk

Question 54

Complete the following statement. The investment proposal with the highest coefficient of variation of net present value (NPV) has:

Choose one answer.

	a. the lowest likelihood of opportunity loss.
	b. the greatest relative risk.
	c. the lowest relative risk.
	d. the highest expected return.

Question 55

What does a company’s financing method reflect?

Choose one answer.

	a. The market value of the firm
	b. The capital structure of the firm—the choice between debt and equity
	c. The firm’s financial risk
	d. None of the above

Question 56

What is a risk map?

Choose one answer.

	a. It is a visual tool used to consider alternatives of the risk management tool.
	b. It is a specialized tool to keep track of cash flow.
	c. It is a map of locations of risky investments.
	d. None of the above

Question 57

What is the objective of risk mapping?

Choose one answer.

	a. To aid in the identification of risks and their interrelations
	b. To provide a mechanism to see clearly what risk management strategy would be the best to undertake
	c. To compare and evaluate the firm’s current risk handling
	d. All of the above

Question 58

What is the role of the chief risk officer (CRO)?

Choose one answer.

	a. The CRO has to keep all company buildings safe and operational.
	b. The CRO gives directions for how to take care of weather-related potential damages or losses from fires or other perils.
	c. The CRO is usually part of the corporation’s executive team and is responsible for all risk elements, including pure and opportunity risks.
	d. None of the above

Question 59

Which of the following is the function of a risk matrix?

Choose one answer.

	a. Risk matrix ranks risks based on frequency/severity combination.
	b. Risk matrix is used to convince management to invest in a new innovation.
	c. Risk matrix reflects risk in a matrix organization.
	d. All of the above

Question 60

Which of the following statements about a firm’s brand equity is true?

Choose one answer.

	a. A firm’s brand equity can be defined as financial securities whose value is derived from another underlying asset.
	b. A firm’s brand equity trades on an exchange with standardized contract specifications.
	c. A firm’s brand equity entails the value created by a company with a good reputation and good products.
	d. None of the above

Question 61

Which of the following statements about loss prevention efforts is true?

Choose one answer.

	a. Loss prevention efforts represent risks of low frequency and low severity.
	b. Loss prevention efforts bear the risk to withstand the financial losses from claims.
	c. Loss prevention efforts seek to reduce the probability of a loss occurring.
	d. Loss prevention efforts transfer parts of the risks to separate smaller subsidiaries.

Question 62

Which of the following statements accurately describes risk profiling?

Choose one answer.

	a. Risk profiling provides an overview of the financial statement of the firm.
	b. Risk profiling includes intellectual property piracy and property rights issues.
	c. Risk profiling is a process that evaluates all the risks of the organizations and measures the frequency and severity of each risk.
	d. Risk profiling provides risk managers with the ability to slice and dice the data.

Question 63

Which of the following statements best describes insureds?

Choose one answer.

	a. Insureds have some risk or variability around the average.
	b. Insureds transfer risk to a third-party.
	c. Insureds accept the risks transferred from an individual or entity.
	d. Both A and C

Question 64

A future trade is guaranteed by which of the following?

Choose one answer.

	a. Clearing house
	b. SEC
	c. US Government
	d. Future exchange

Question 65

Agreements that give the right (but not the obligation) to buy or sell an underlying asset at a specified price at a specified time in the future are known as which of the following?

Choose one answer.

	a. Options
	b. Futures
	c. Contract agreements
	d. Forwards

Question 66

Calculate the basis of a 6-month future of wheat, which is priced at 515 cents per bushel. The cash price of wheat today is 500 cents per bushel.

Choose one answer.

	a. 15 cents
	b. -15 cents
	c. 510 cents
	d. 515 cents

Question 67

Complete the following sentence. A computerized database that facilitates storage and analysis of risk-related data is called:

Choose one answer.

	a. a risk management information system.
	b. a risk matrix.
	c. a risk map.
	d. an enterprise risk management.

Question 68

Complete the following statement. Future exchanges require all contracts to be:

Choose one answer.

	a. paid by cash.
	b. traded by stock brokers.
	c. marked to market.
	d. annulled.

Question 69

Fill in the blank. Management must consider a trade-off between_____________ when determining the appropriate level of current assets for the firm.

Choose one answer.

	a. liquidity and marketability
	b. risk and profitability
	c. debt and profitability
	d. equity and liquidity

Question 70

Fill in the blank. The CEO of XYZ Inc. has decided to create a(n) ____________ to consider all risks faced by XYZ Inc., including pure, speculative, operational, and strategic risks.

Choose one answer.

	a. financial risk management program
	b. operational risk program
	c. enterprise risk management program
	d. insurance program

Question 71

Financial risk managers are responsible for doing which of the following?

Choose one answer.

	a. Deciding on finance acquisitions with debt versus equity
	b. Managing the risk of the investments and assets of the firms
	c. Managing the opportunity risk and the chance to make money
	d. Showing the gains and losses that can occur because of interest rate and currency risks

Question 72

How are forwards traded?

Choose one answer.

	a. Forwards are traded in the over-the-counter market, and contract characteristics can be tailored to meet specific customer needs.
	b. Forwards are traded on an exchange with standardized contract specifications.
	c. Forwards are not publicly traded.
	d. Both A and B

Question 73

How are futures traded?

Choose one answer.

	a. Futures are traded on an exchange with non-standardized contract specifications.
	b. Futures are traded on an exchange with standardized contract specifications.
	c. Futures are not traded on an exchange.
	d. Both B and C

Question 74

Packaging and transferring the insurance risks to the capital markets through the issuance of a financial security is known as which of the following?

Choose one answer.

	a. Securities
	b. Obligations
	c. Securitization
	d. Both A and B

Question 75

What are collateralized debt obligations (CDOs)?

Choose one answer.

	a. They are securities backed by a pool of diversified assets.
	b. They are values that derive from another underlying asset.
	c. They are derivative contracts that pay based on weather-related events.
	d. None of the above

Question 76

What are covenants?

Choose one answer.

	a. The details of the contracts and promises between the debt contract parties
	b. Transactions that create needs for interest-rate management while receiving interest from clients
	c. Risks that would affect both receivables and payments to vendors, designers, and suppliers
	d. Interest rates in line with what can be collected in the accounts receivable

Question 77

What are derivatives?

Choose one answer.

	a. Financial securities whose value is derived from another underlying asset
	b. Connections between the firm’s risk and profit
	c. Choices in how an enterprise risk manager might mitigate risks
	d. Both A and B

Question 78

What are swaps?

Choose one answer.

	a. Agreements to transfer expected future variable-price purchases of a commodity or foreign exchange contract for a fixed contractual price today
	b. Agreements that give the right (but not the obligation) to buy or sell an underlying asset at a specified price at a specified time in the future
	c. A transfer of the insurance risks to the capital markets
	d. Both B and C

Question 79

What are weather derivatives?

Choose one answer.

	a. They are derivative contracts that do not pay based on weather-related events.
	b. They are securities backed by a pool of diversified assets.
	c. They are not insurable by private insurers.
	d. They are derivative contracts that pay based on weather-related events.

Question 80

What is the function of a Risk Management Information System (RMIS)?

Choose one answer.

	a. To collect data
	b. To facilitate data analysis to identify and evaluate risks
	c. To quantify and estimate frequency and probability distributions as well as to perform trend analysis
	d. All of the above

Question 81

What is underwriting?

Choose one answer.

	a. It is the process of evaluating risks, selecting which risks to accept, and identifying potential adverse selection.
	b. It is the process of creating financial models.
	c. It is the process of maximizing a company’s stock value.
	d. Both A and C

Question 82

Which of the following about enterprise risk management (ERM) is false?

Choose one answer.

	a. ERM is designed to identify potential events that affect the entity.
	b. ERM helps the organization to manage risk within its risk appetite.
	c. ERM only involves people at the executive and director levels.
	d. ERM is applied in strategy-setting and provides assurance to management and board of the company.

Question 83

Which of the following is true of catastrophe bonds (CAT bond)?

Choose one answer.

	a. They are insurance-related derivatives/options.
	b. They transfer risk from the insurers to the capital markets.
	c. They seek to protect the insurance industry from catastrophic events.
	d. Both A and B

Question 84

Complete the following sentence. A risk is generally insurable if the loss is:

Choose one answer.

	a. speculative.
	b. quantifiable.
	c. pure risk.
	d. economic changes.

Question 85

Fill in the blank. To be _________, the size of the possible loss must be significant to the insured, and the cost of insurance must be small compared to the potential loss.

Choose one answer.

	a. economically feasible
	b. fortuitous
	c. catastrophic
	d. dependent

Question 86

Monte Carlo simulation is used to analyze which of the following?

Choose one answer.

	a. The effect of changing all possible combinations of variables on the predicted outcomes of a decision
	b. The effect of changing one variable on the predicted outcomes of a decision
	c. The effect of changing a limited number of variables on the predicted outcomes of a decision
	d. How the predicted outcomes of a decision depend on a variable

Question 87

The law of large numbers holds that as the sample size of observations increases, which of the following occurs?

Choose one answer.

	a. The relative variation about the sample mean increases.
	b. The variance of the sample mean declines.
	c. The expected value of the sample is kept constant.
	d. None of the above

Question 88

What are contingent surplus notes?

Choose one answer.

	a. The amount of money above and beyond the future price
	b. Values that derive from another underlying asset
	c. Options to borrow money in case of a specific event
	d. Different choices in how an enterprise risk manager might mitigate the unwanted price exposure

Question 89

What is captive insurance?

Choose one answer.

	a. A captive insurance company provides insurance coverage to its parent company and other affiliated organizations.
	b. Captive insurance is a method to transfer risk to US government.
	c. Captive insurance is the combination of risk pooling and risk transfer from the owner of the risk to a third, unrelated party.
	d. None of the above

Question 90

What is personal insurance?

Choose one answer.

	a. It is insurance provided by the employer for the benefit of employees.
	b. It is health insurance provided by the government.
	c. It is insurance that is purchased by individuals and families for their risk needs including life, health, disability, auto, homeowner, and long-term care.
	d. None of the above

Question 91

Which of the following statements about catastrophe equity puts (Cat-E-Puts) is true?

Choose one answer.

	a. Cat-E-Puts give the insurer the option to sell equity at predetermined prices, contingent upon the catastrophic event.
	b. Cat-E-Puts give the insurer the option to purchase equity (e.g., preferred shares) at predetermined prices, contingent upon the catastrophic event.
	c. Cat-E-Puts give the insurer the option to cancel a future contract.
	d. Cat-E-Puts give the insurer the option to cancel a forward contract.

Question 92

Which of the following statements about property/casualty insurance is true?

Choose one answer.

	a. It covers exposures to the perils of death, medical expenses, disability, and old age.
	b. It covers property exposures such as direct and indirect losses of property caused by perils like fire, windstorm, and theft.
	c. It is insurance provided by the employer for the benefit of employees.
	d. It is a form of involuntary social insurance provided by the government.

Question 93

Which of the following statements about simulation models for risk analysis is false?

Choose one answer.

	a. Simulation models are complex and resource-demanding.
	b. Simulation models allow for the exploration of different scenarios.
	c. Once developed, simulation models can be applied to all types of investments in all situations.
	d. Simulation models are as good as the assumptions underlying the model.

Question 94

Why is a large number of exposure units required for a pure risk to be insurable?

Choose one answer.

	a. It reduces losses.
	b. It allows the insurer to estimate losses using the law of large number.
	c. It creates larger social benefits.
	d. It reduces the cost of insurance.