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Exam 11: Time and Uncertainty

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Question 61

Multiple Choice

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In general, the amount people pay for insurance is:

A) lower than its expected value.
B) higher than its expected value.
C) higher than its future value.
D) lower than its present value.

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

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Question 62

Multiple Choice

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Insurance companies try to mitigate the problem of adverse selection by:

A) asking potential customers questions to gain as much information as possible about the person's risk characteristics.
B) charging a higher premium to groups with characteristics that correlate with risky behavior.
C) charging a higher price to all individuals to counter the lack of information.
D) All of these are true.

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

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Question 63

Multiple Choice

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The value of a deposit amount X with interest r after one period equals:

Benefits today cannot be directly compared with costs in the future because:

Which of the following is closest to the future value of an $800,000 deposit earning 2 percent interest annually after 20 years?

What is the foundational principle that allows insurance companies to work?

To compute the present value of a future amount, you must know the _______ and the _______.

What is the amount of interest owed on a loan of $75,000 after a year at an interest rate of 1 percent?

When thinking about investing money in _______, one must consider the trade-off between risk and expected value.

The present value of $500,000 received in 4 years at 7 percent interest is approximately:

Economists have observed that individuals have _______ tastes for taking on financial risks and are _______ in general.

Consider two insurance companies. Insurance Company A insures homes in Florida against hurricane damage. Insurance Company B insures homes in Oklahoma against tornado damage. Suppose that in the next year, there is a 20 percent chance that Florida will be hit by a devastating hurricane. If it does, Company A will lose $3 million. If no hurricane hits Florida, Company A will earn $5 million in profits. Suppose that also in the next year, there is a 10 percent chance that Oklahoma will be hit by a devastating tornado. If it does, Company B will lose $2 million. If there is no tornado, Company B will earn $4 million in profits.Now suppose that these two companies are considering a merger. If they merge, they will split their profits or losses equally. The potential outcomes and their probabilities are as follows:72 percent chance of neither a hurricane nor a tornado occurring;18 percent chance of a hurricane occurring, but not a tornado;8 percent chance of a tornado occurring, but not a hurricane;2 percent chance of both a tornado and a hurricane occurring.Which of the following statements is true?The expected value of Company A's earnings is the same whether or not the companies merge.If Company A is risk averse, the company would prefer to merge.The expected value of Company B's earnings is $3,400,000 if there is no merger.

Consider two insurance companies. Insurance Company A insures homes in Florida against hurricane damage. Insurance Company B insures homes in Oklahoma against tornado damage. Suppose that in the next year, there is a 20 percent chance that Florida will be hit by a devastating hurricane. If it does, Company A will lose $3 million. If no hurricane hits Florida, Company A will earn $5 million in profits. Suppose that also in the next year, there is a 10 percent chance that Oklahoma will be hit by a devastating tornado. If it does, Company B will lose $2 million. If there is no tornado, Company B will earn $4 million in profits.Now suppose that these two companies are considering a merger. If they merge, they will split their profits or losses equally. The potential outcomes and their probabilities are as follows:72 percent chance of neither a hurricane nor a tornado occurring;18 percent chance of a hurricane occurring, but not a tornado;8 percent chance of a tornado occurring, but not a hurricane;2 percent chance of both a tornado and a hurricane occurring.Which of the following statements is true?

The fee that insurance companies collect in exchange for covering unpredictable costs is called a(n) :

When deciding whether or not to purchase insurance for an event, it is important to know:

Risk pooling:

A deposit of $500 after a year at 3 percent interest has a value of:

If you knew that an investment was going to pay you $128 in 5 years, and you knew that the annual interest rate over that time would be 5 percent, you could calculate the present value to be:

In general, people are willing to pay more than the expected value of insurance because:

Insurance policies can be bought to cover unexpected costs due to: