Question 1

Identify the correct statement about corporations.
A)Corporations are risk neutral because they can diversify all risks except idiosyncratic risk.
B)Corporations should ideally hedge risks only at prices lower than the AFP.
C)Corporations buy hedging instruments at greater price than AFP.
D)The individual level utility functions of risk aversion can explain the hedging behavior of corporations.
E)Corporations are risk neutral because they can diversify systematic risk.

Accepted Answer

Corporations often engage in hedging to manage risk, and in doing so, they may end up paying a premium over the actuarially fair price (AFP) for hedging instruments. This is because the value of reducing risk exposure can outweigh the cost, especially for risks that can have significant impacts on their operations or financial stability.

Question 2

Information asymmetry problem related to hidden information is referred to as:
A)prisoner's dilemma.
B)principle-agent problem.
C)moral hazard.
D)adverse selection.
E)fundamental attribution error.

Accepted Answer

Adverse selection is the term used to describe a situation where there is a problem of hidden information, leading one party to make decisions that adversely affect another party because they do not have the same information.

Question 3

_____ theory dictates that people should behave in the manner prescribed by it.

Accepted Answer

The answer of _____ theory dictates that people should behave...

Question 4

Systematic departures in behavior from the EU principle stem from "biases" that people exhibit.Such rationales of observed behavior under uncertainty are termed "_____" explanations.

Accepted Answer

The answer of Systematic departures in behavior from the EU...

Question 5

A(n) _____ is a mathematical formulation that ranks the preferences of the individual in terms of satisfaction different consumption bundles provide.

Accepted Answer

The answer of A(n) _____ is a mathematical formulation that...

Question 6

Regulated companies are found to hedge more than unregulated ones because:
A)regulated companies face more risk.
B)hedging can increase debt capacity.
C)unregulated companies face more risk.
D)unregulated companies are prohibited from hedging.
E)law limits the level of risk taking.

Accepted Answer

The answer of Regulated companies are found to hedge more...

Question 7

Which of the following statements is true about the value function?
A)It is a mathematical formulation that seeks to explain observed behavior by making assumptions about preferences.
B)Economists say that it is risk seeking in losses and risk averse in gains.
C)In the language of mathematics it is concave in losses and convex in gains.
D)Economists say that it is risk averse in losses and risk seeking in gains.
E)The nature of the value function is such that it is much steeper in gains than in losses.

Accepted Answer

The answer of Which of the following statements is true...

Question 8

Economists use the term "_____" to gauge a person's satisfaction level.

Accepted Answer

The answer of Economists use the term "_____" to gauge...

Question 9

Often individuals base their subjective assessments of outcomes based on an initial "guesstimate." Such a guess may not have any reasonable relationship to the outcomes being studied.Identify this bias.
A)Self-serving bias
B)Attributional bias
C)Availability bias
D)Experience bias
E)Anchoring bias

Accepted Answer

This is known as the anchoring bias, where individuals rely too heavily on an initial piece of information (the "anchor") when making decisions, even if that initial information is unrelated or irrelevant to the decision at hand.

Question 10

The principle-agent problem can be categorized as an information symmetry problem.Identify this information symmetry.
A)Adverse selection
B)Fundamental attribution error
C)Prisoner's dilemma
D)Moral hazard
E)False consensus

Accepted Answer

Moral hazard is a type of information asymmetry in which one party (the agent) has more information than the other party (the principal). This can lead to problems because the agent may take actions that are not in the best interests of the principal.

Question 11

Which of the following statements is true companies hedging behavior?
A)Managers hedge because they are diversified.
B)Hedging can increase debt capacity.
C)Unregulated companies are found to hedge more than regulated ones.
D)Managers want to increase expected bankruptcy costs.
E)Managers hedge because owners are undiversified.

Accepted Answer

Hedging can increase debt capacity by reducing the volatility of a company's cash flows, making it easier to service debt and potentially allowing the company to take on more debt.

Question 12

Humans tend to give more weight to events of the recent past than to look at the entire history.Which of the following best explains this bias?
A)Anchoring bias
B)Attributional bias
C)Availability bias
D)Experience bias
E)Conformation bias

Accepted Answer

Availability bias explains this tendency because it describes how people judge the frequency or likelihood of events by the ease with which examples come to mind, which often means recent events are given more weight.

Question 13

Optimal capital structure is a company's optimal mix of:
A)short-term and long-term loans.
B)common and preference shares.
C)short-term and long-term liabilities.
D)debt and equity financing.
E)bills receivable and bills payable.

Accepted Answer

Optimal capital structure refers to the best mix of debt and equity financing that maximizes a company's market value while minimizing its cost of capital.

Question 14

According to the utility theory, the property wherein an individual's preferences enable him or her to compare any given bundle with any other bundle is called the _____ property of preferences.

Accepted Answer

The answer of According to the utility theory, the property...

Question 15

A store owner may not be available to monitor the manager' actions continuously and at all times.This inability to observe actions falls under the class of problems called:
A)the principle-agent problem.
B)adverse selection.
C)the conflict of interest.
D)the false consensus problem.
E)fundamental attribution error.

Accepted Answer

The principal-agent problem occurs when one party (the principal) cannot fully monitor the actions of another party (the agent), leading to potential misalignment of interests. In this scenario, the store owner (principal) cannot continuously monitor the manager (agent), fitting the definition of the principal-agent problem.

Question 16

Information asymmetry problem related to hidden action is referred to as:
A)prisoner's dilemma.
B)principle-agent problem.
C)moral hazard.
D)adverse selection.
E)fundamental attribution error.

Accepted Answer

Moral hazard refers to the situation where one party in a transaction takes on more risk because they know that the other party bears the consequences of their actions, which is a classic example of information asymmetry related to hidden actions.

Question 17

In the utility theory, under the assumption of _____, individuals' preferences avoid any kind of circularity.

Accepted Answer

The answer of In the utility theory, under the assumption...

Question 18

_____ utility is utility that can represent the absolute level of satisfaction.

Accepted Answer

The answer of _____ utility is utility that can represent...

Question 19

Under partial insurance, companies offer products with deductibles.If an individual opts for a deductible, he/she will have to:
A)bear the entire loss incurred and then get it reimbursed form the insurance company.
B)bear the initial part of the losses incurred.
C)pay very high premiums to gain adequate protection.
D)opt for a whole life insurance policy as additional insurance.
E)return fifty percent of the amount received as face value, back to the insurer.

Accepted Answer

Deductibles are a portion of the loss that the insured must pay out of pocket before the insurance company pays the remaining amount. This means the insured bears the initial part of the losses.

Question 20

According to the utility theory, the _____ assumption is called the "convexity" assumption on preferences.

Accepted Answer

The answer of According to the utility theory, the _____...

Quiz 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging

Identify the correct statement about corporations.

Information asymmetry problem related to hidden information is referred to as:

_____ theory dictates that people should behave in the manner prescribed by it.

Systematic departures in behavior from the EU principle stem from "biases" that people exhibit.Such rationales of observed behavior under uncertainty are termed "_____" explanations.

A(n) _____ is a mathematical formulation that ranks the preferences of the individual in terms of satisfaction different consumption bundles provide.

Regulated companies are found to hedge more than unregulated ones because:

Which of the following statements is true about the value function?

Economists use the term "_____" to gauge a person's satisfaction level.

Often individuals base their subjective assessments of outcomes based on an initial "guesstimate." Such a guess may not have any reasonable relationship to the outcomes being studied.Identify this bias.

The principle-agent problem can be categorized as an information symmetry problem.Identify this information symmetry.

Which of the following statements is true companies hedging behavior?

Humans tend to give more weight to events of the recent past than to look at the entire history.Which of the following best explains this bias?

Optimal capital structure is a company's optimal mix of:

According to the utility theory, the property wherein an individual's preferences enable him or her to compare any given bundle with any other bundle is called the _____ property of preferences.

A store owner may not be available to monitor the manager' actions continuously and at all times.This inability to observe actions falls under the class of problems called:

Information asymmetry problem related to hidden action is referred to as:

In the utility theory, under the assumption of _____, individuals' preferences avoid any kind of circularity.

_____ utility is utility that can represent the absolute level of satisfaction.

Under partial insurance, companies offer products with deductibles.If an individual opts for a deductible, he/she will have to:

According to the utility theory, the _____ assumption is called the "convexity" assumption on preferences.