• Home
  • Textbooks
  • Economics
  • Risk and information

Economics

David Begg, Gianluigi Vernasca, Stanley Fische

Chapter 12

Risk and information - all with Video Answers

Educators

Chapter Questions

01:48

Problem 1

\mathrm{~A}$ fair coin is to be tossed. If it comes down heads, the player wins $£ 1$. If it comes down tails, the player loses $£ 1$. Person A doesn't mind whether or not she takes the bet. Person B will pay $£ 0.02$ to play the game. Person C demands $£ 0.05$ before being willing to play. Characterize the three people's attitudes to risk. Which person is most likely to take out insurance against car theft ?

Aman Gupta
Aman Gupta
Numerade Educator
02:44

Problem 2

In which of the following are the risks being pooled: (a) life insurance, (b) insurance against the Thames flooding, (c) insurance for a pop star's voice ?

Jesse Neumann
Jesse Neumann
Numerade Educator
03:15

Problem 3

You see an advert for life insurance for anyone over 45 years old. No medical examination is required. Do you expect the premium rates to be high, low or average ? Why?

Puneet Prajapati
Puneet Prajapati
Numerade Educator
01:49

Problem 4

True or False Your lecturer says that the economics exam she is setting is so easy that no students will fail. Given that information, no students prepare for the exam and they all fail. This is an example of an adverse selection problem.

Haricharan Gupta
Haricharan Gupta
Numerade Educator
02:58

Problem 5

Common fallacies Why are the following statements wrong ? (a) Economists cannot predict changes in the stock market. This proves that economics is useless in thinking about share prices. (b) It is silly to take out insurance. If the insurance company is making money, its clients are losing money. (c) Prudent investors should not buy shares whose returns are volatile.

Vaibhav Jain
Vaibhav Jain
Numerade Educator
03:16

Problem 6

Suppose that Philip has a total utility of income given by $\mathrm{U}(\mathrm{I})=\mathrm{I}$, where $I$ denotes income. In a graph with utility on the vertical axis and income on the horizontal axis, plot Philip's total utility of income. What is Philip's attitude towards risk? Explain.

Luis Fernando Olloqui Regalado
Luis Fernando Olloqui Regalado
Numerade Educator
05:53

Problem 7

Suppose that Philip, whose total utility of income is given by $\mathrm{U}(\mathrm{I})=\mathrm{I}$, can have two income levels this year: if he keeps his job, he earns $£ 30000$; if he loses his job, he must live on a subsistence payment from the government of $£ 10000$. Philip thinks he has a $50-50$ chance of losing his job when he talks to his boss tomorrow. He is thus considering purchasing employment insurance today. The insurance company will pay him $£ 20000$ if he loses his job; otherwise, it will pay nothing. The insurance payment does not affect the subsistence payment from the government. The insurance costs $£ 10000$, which he must pay now. Using the graph from Question 6 , show the possible income levels Philip faces. Should Philip buy the insurance ? Explain.

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator
02:10

Problem 8

We know from many situations that people will pay to avoid risk. Name three risky products that you could choose to buy. In each case, explain the motive.

Haricharan Gupta
Haricharan Gupta
Numerade Educator
View

Problem 9

What kind of information asymmetry do stock markets face which requires that these markets be regulated ?

Rashmi Sinha
Rashmi Sinha
Numerade Educator
01:38

Problem 10

You set up a firm to advise the unemployed on the best way to use their time to earn money. Your firm issues shares on the stock market. In equilibrium, will your shares be expected to earn a higher or lower return than the stock market average ? Why?

Haricharan Gupta
Haricharan Gupta
Numerade Educator
01:59

Problem 11

Suppose the stock exchange is expected to yield a return of 5 per cent next year, but this is risky and could be several percentage points either side of the central forecast. You are also aware that it is possible to hold gold as an asset and that gold is known to have a small negative beta. People buy gold in a panic, so the gold price rises when the stock market is doing badly. Today, the price of gold is £100. (a) If people are risk-neutral, what is the best estimate of next year's gold price ? (b) If people are risk-averse, what do you think is the best estimate of next year's gold price ?

Achintya Suden
Achintya Suden
Numerade Educator
02:44

Problem 12

The total utility of the income of an individual is reported in the following table:
In a graph with utility on the vertical axis and income on the horizontal axis, plot the total utility of income of the individual. Suppose our individual has an initial income of $£ 4$. He can use this money in a fair gamble that gives him an income of £6, with probability $0.5$, and with probability $0.5$, an income of $£ 2$. Should the individual put his income into this fair gamble ? Use the graph of the total utility of income to illustrate your answer.

Bobby Barnes
Bobby Barnes
University of North Texas
03:40

Problem 13

Essay question You run a pension fund and know that in 20 years' time you need
to make a lot of payments to people who will then have retired. Should you: (a) invest in bonds that mature in 20 years' time so you know exactly how much you will then have, (b) invest in equities because historically their average return has been greater than bonds in the long run, or (c) begin mainly in equities but switch gradually into bonds as the 20 -year period elapses ?

Neel Faucher
Neel Faucher
Numerade Educator
08:34

Problem 14

Suppose you have 1 tonne of coffee to be sold in a year's time. The spot price of coffee today is $£ 1000$. The spot price of coffee is expected to be $£ 1300$ next year. How would you protect yourself from risk and make the most out of this trade ?

Joy Carpio
Joy Carpio
Numerade Educator