Finance: Risk Aversion and Question

Question 1
(5 points) Shareholders of Sparky's Kerosene Company (SKC) face a variety of risks in holding SKC shares. If SKC purchases fire insurance for their factories, their shareholders will face lower
Your Answer

Score
Explanation
Systematic/Market Risk.

Specific/Idiosyncratic Risk.
Correct
5.00
Correct. You have a good intuition for fundamental types of risk.
Total

5.00 / 5.00

Question Explanation

A fundamental question about different types of risks.
Question 2
(5 points) Suppose there are three securities (X, Y, and Z) to choose from, and next year the economy will be in an expansion, normal, or recession state with probabilities 0.30, 0.35, and 0.35, respectively. The returns (%) on the securitiies in these states are as follows: Security X {expansion = +10, normal = +8, recession = +6}; Security Y {+25,+10,-10}; Security Z {+7.5,+7.5,+7.5}. If the investor is risk neutral and must choose whether to invest in Security Y or Security Z, which would she buy?
Your Answer

Score
Explanation
Security Y.

Indifferent between Y & Z.
Correct
5.00
Correct. You know that she will choose based exclusively on expected returns
Security Z.

Total

5.00 / 5.00

Question Explanation

This is a question that makes you calculate expected returns and, given the investor's attitude toward risk, also asks you to make a choice on her behalf.
Question 3
(5 points) Suppose your dear old Grandfather approaches you for investment advice. He knows of your great training in finance and statistics and gives the following instructions: "Obviously, I want to maximize my returns, but since my life is now quite boring, I also enjoy a good thrill. My first priority is to pick the security with the highest return. After that, pick me the most volatile investment so I can enjoy the thrills of holding risk." Suppose there are three securities (X, Y, and Z) to choose from next year, the economy will be in an expansion, normal, or