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Which of the following is not correct?


A) The higher average return on stocks than on bonds comes at the price of higher risk.
B) Risk-averse persons will take the risks involved in holding stocks if the average return is high enough to compensate for the risk.
C) Insurance markets reduce risk, but not by diversification.
D) Risk can be reduced by placing a large number of small bets, rather than a small number of large bets.

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

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You could borrow $1,000 today from Bank A and repay the loan, with interest, by paying Bank A $1,060 one year from today. Or, you could borrow $1,500 today from Bank B and repay the loan, with interest, by paying Bank B $1,600 one year from today. Which of the following statements is correct? A) The interest rate on the loan from Bank A is higher than the interest rate on the loan from Bank B. B) The interest rate on the loan from Bank A is lower than the interest rate on the loan from Bank B. C) The interest rates on the two loans are the same. D) There is not enough information to determine which loan has the higher interest rate.

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Other things the same, as the number of stocks in a portfolio rises,


A) risk increases and the standard deviation of the return rises.
B) risk increases and the standard deviation of the return falls.
C) risk decreases and the standard deviation of the return rises.
D) risk decreases and the standard deviation of the return falls.

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

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Which of the following best illustrates moral hazard?


A) After a person obtains life insurance, she takes up skydiving.
B) A person obtains insurance knowing he is in poor health.
C) A person holds stock only in very risky corporations.
D) A person holds stocks from only a few corporations.

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

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What is the present value of a payment of $100 to be made one year from today if the interest rate is 6 percent?


A) $105.26
B) $105.00
C) $97.24
D) $94.34

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

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Which of the following is not correct?


A) There is a greater reduction in risk by increasing the number of stocks in a portfolio from 1 to 10, than by increasing it from 100 to 120 stocks.
B) The historical rate of return on stocks has been about 5 percentage points higher than the historical rate of return on bonds.
C) Stock in an industry that is very sensitive to economic conditions is likely to have a higher average return than stock in an industry that is not so sensitive to economic conditions.
D) If you had information about a corporation that no one else had, you could earn a very high rate of return. This contradicts the efficient market hypothesis.

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

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Increasing the number of corporations whose stocks are in your portfolio reduces market risk.

A) True
B) False

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A risk-averse person has


A) utility and marginal utility curves that slope upward.
B) utility and marginal utility curves that slope downward.
C) a utility curve that slopes down and a marginal utility curve that slopes upward.
D) a utility curve that slopes upward and a marginal utility curve that slopes downward.

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

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What's the difference between firm-specific risk and market risk? Will diversification eliminate one or both? Explain.

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Market risk refers to economy wide risk ...

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Mary Beth is risk averse and has $1,000 with which to make a financial investment. She has three options. Option A is a risk-free government bond that pays 5 percent interest each year for two years. Option B is a low-risk stock that analysts expect to be worth about $1,102.50 in two years. Option C is a high-risk stock that is expected to be worth about $1,200 in four years. Mary Beth should choose


A) option A.
B) option B.
C) option C.
D) either A or B because they are the same to her.

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

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The price of a bond is equal to the sum of the present values of its future payments. Suppose a certain bond pays $50 one year from today and $1,050 two years from today. What is the price of the bond if the interest rate is 5 percent?


A) $1,050.00
B) $1,045.35
C) $1,000.00
D) $945.35

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

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Imagine that someone offers you $100 today or $200 in 10 years. You would prefer to take the $100 today if the interest rate is


A) 4 percent.
B) 6 percent.
C) 8 percent.
D) All of the above are correct.

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

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The field of finance primarily studies


A) how society manages its scarce resources.
B) the implications of time and risk for allocating resources over time.
C) firms' decisions concerning how much to produce and what price to charge.
D) how society can reduce market risk.

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

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Give an example of adverse selection and an example of moral hazard using homeowners insurance.

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An example of adverse selection is that ...

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Sage decides to cash in all his savings to open a recording studio. He has three accounts to cash in. The first earned 9 percent for two years. The second earned 6 percent for three years. And the last earned 3 percent for six years. Supposing he started with $5,000 in each account, from which account will he get the most cash?


A) the two-year account at 9 percent
B) the three-year account at 6 percent
C) the six-year account at 3 percent
D) The accounts are all worth the same.

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

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Historically the return on stocks has been higher than the return on bonds. In part this reflects the higher risk from holding stock.

A) True
B) False

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There are many concerns for risk-averse lenders. Consider the following: 1. Lenders are concerned that borrowers with the greatest risk are the ones most likely to actively pursue loans. 2. Lenders are concerned that real GDP will decline leading to reduced corporate profits. 3. Lenders are concerned that products produced by certain corporations will become obsolete.


A) 1 is market risk; 2 is firm-specific risk
B) 2 is market risk; 3 is firm-specific risk
C) 3 is market risk; 1 is firm-specific risk
D) 2 is firm-specific risk; 3 is market risk

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

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If you put $1,000 in the bank today at an interest rate of 6% what is its value in two years?


A) $2,0001.06)
B) $1,000 + $1.06) 2
C) $1,0001.06) 2
D) None of the above are correct.

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

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Write the formula to find the present value of $750 to be paid in 5 years if the interest rate is 3 percent.

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Suppose that Albert can buy a bond for $1,000 that matures in two years and pays Albert $1,102.5 with certainty. He is indifferent between this bond and one that has some risk but on which the interest rate is 3% higher. How much, to the nearest penny, does the riskier bond pay in two years?


A) $1,160.00
B) $1,166.40
C) $1,168.65
D) $1,169.64

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

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