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Exam 11: Time and Uncertainty

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Question 21

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Present value:

A) translates future costs or benefits into the equivalent amount of cash in hand today.
B) enables us to compare the future amounts directly with the immediate amounts.
C) is the future value divided by (1 + r) ⁿ where r is the interest rate and n is the number of years in the future at which the balance is received.
D) All of these statements are true.

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

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Question 22

Multiple Choice

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The amount of interest owed on a loan of $40,000 after a year at an interest rate of 4 percent is:

A) $1,600.
B) $41,600.
C) $40,400.
D) $160.

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

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Question 23

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

Value of a loan amount X with interest r after one period equals:

The amount of interest owed on a loan of $75,000 after a year at an interest rate of 1 percent is:

Suppose Jack and Kate are at the town fair and are choosing which game to play.The first game has a bag with four marbles in it-1 red marble and 3 blue ones.The player draws one marble from the bag;if it is red,they win $20 and if it is blue,they win $1.The second game has a bag with 10 marbles in it-1 red,4 blue,and 5 green.The player draws one marble from the bag;if it is red,they win $20;if it is blue,they win $5;and if it is green,they win $1.Both games cost $5 to play.If Jack only cares about expected value,and not risk,he should decide to play a game if:

Suppose Jack and Kate are at the town fair and are choosing which game to play.The first game has a bag with four marbles in it-1 red marble and 3 blue ones.The player draws one marble from the bag;if it is red,they win $20 and if it is blue,they win $1.The second game has a bag with 10 marbles in it-1 red,4 blue,and 5 green.The player draws one marble from the bag;if it is red,they win $20;if it is blue,they win $5;and if it is green,they win $1.Both games cost $5 to play.What is the probability of drawing a red marble in each game?

The foundational principle that makes insurance companies work is called:

Suppose Jack and Kate are at the town fair and are choosing which game to play.The first game has a bag with four marbles in it-1 red marble and 3 blue ones.The player draws one marble from the bag;if it is red,they win $20 and if it is blue,they win $1.The second game has a bag with 10 marbles in it-1 red,4 blue,and 5 green.The player draws one marble from the bag;if it is red,they win $20;if it is blue,they win $5;and if it is green,they win $1.Both games cost $5 to play.Assume Jack will play the games that have a higher expected payoff than the cost of playing the game.Comparing the expected value of the payoff of each game to the price of $5 to play,we can conclude that Jack should:

Compounding:

If you want to own $1 million when you retire in 45 years,how much should you put into your retirement fund now,given the interest rate is 3 percent?

The value of a loan of $500 after a year at 3 percent interest is:

Risk pooling:

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:

The value of a loan of $50,000 after a year at 2 percent interest is:

When risks are shared across many different assets or people,reducing the impact of any particular risk on any one individual,it is called:

Suppose Jack and Kate are at the town fair and are choosing which game to play.The first game has a bag with four marbles in it-1 red marble and 3 blue ones.The player draws one marble from the bag;if it is red,they win $20 and if it is blue,they win $1.The second game has a bag with 10 marbles in it-1 red,4 blue,and 5 green.The player draws one marble from the bag;if it is red,they win $20;if it is blue,they win $5;and if it is green,they win $1.Both games cost $5 to play.Jack decides to play the first game,and Kate decides to play the second game as described in the scenario.The expected value of the payoff:

John is trying to decide whether to expand his business or not.If he continues his business as it is,with no expansion,there is a 50 percent chance he will earn $100,000 and a 50 percent chance he will earn $300,000.If he does expand,there is a 30 percent chance he will earn $100,000,a 30 percent chance he will earn $300,000 and a 40 percent chance he will earn $500,000.It will cost him $150,000 to expand.To make the best decision,John should compare:

Suppose Jack and Kate are at the town fair and are choosing which game to play.The first game has a bag with four marbles in it-1 red marble and 3 blue ones.The player draws one marble from the bag;if it is red,they win $20 and if it is blue,they win $1.The second game has a bag with 10 marbles in it-1 red,4 blue,and 5 green.The player draws one marble from the bag;if it is red,they win $20;if it is blue,they win $5;and if it is green,they win $1.Both games cost $5 to play.Kate is considering whether to play the second game.If Kate only cares about the expected value of the outcome and does not care about risk,she should:

A risk-seeker is likely to: