Question

8. Suppose you expect a significant career or family change in three years, which requires substantial initial capital commitment (e.g., starting your own business, relocating abroad, buying a house, children going to college, etc.). Which of the following seems to be the most appropriate investment strategy? ____

   a. Take a loan to buy an investment condo.
   b. Use your savings to buy a small number of stocks that you believe to rise in price. c. Use your savings to buy well-diversified stock mutual fund shares.
   d. Use your savings to buy well-diversified bond mutual fund shares.

9. In addition to allocating money for anticipated future capital expenditure, you also need to save some money for unexpected future events (e.g., job loss, major sickness or injury, etc.). Which one of the followings is likely to be the best place to put your emergency reserve in? ____

   a. Put the money in your 401(k) and invest it in stock mutual funds.
   b. Put the money in your 401(k) and invest it in money market mutual funds.
   c. Put the money in your Roth IRA and invest it in money market mutual funds.
   d. Put the money in your regular taxable investment account and invest it in money market mutual funds.

10. In finance, human capital of an investor is defined as the present value of all the future earnings of this person. For young investors, human capital usually constitutes a large percentage of their total wealth. Human capital is subject to mortality risk— the likelihood that the investor dies prematurely and therefore loses all the labor income of subsequent working years. The loss of an investor’s human capital is borne by his/her family. Life insurance policy provides protection against mortality risk. Which of the followings is likely to be the best life insurance choice for you and your spouse? ____

    1. Buy a small life policy in the beginning and gradually increase the death benefit

       as you and your spouse age.

    2. Buy a large life policy in the beginning and gradually reduce the death benefit as

       you and your spouse age.

    3. Buy a life policy with the death benefit you see fit in the beginning and keep the

       death benefit unchanged as you and your spouse age.

    4. Do not consider buying a life policy until you and your spouse retire.

11. While insurance is an effective way to protect against undesirable risk, it is by no means the only way. There exist many other tools for personal risk management. Cash reserve is one such example. By keeping cash reserve, you self-insure against unexpected future loss. Compared with self-insurance using cash reserve, buying insurance has both pros and cons. The biggest pro is mortality pooling—more efficient to manage risk on the group level than on the individual level. The biggest con is the high price of insurance policy. The high insurance premium results not just from an insurance company’s costs of producing the insurance but also from the high costs to market it (e.g., commissions paid to insurance agents) and the additional costs caused the prevalent adverse selection and moral hazard problems in the insurance market as well as the insurance company’s profit. So, you need to weigh the pros against the cons to decide whether to buy insurance. All of the following insurances are worth buying EXCEPT ____.

    1. Liability insurance

    2. Homeowner insurance

    3. Extended warranty on consumer electronics

    4. Umbrella insurance

Answer 1

• The most appropriate investment strategy would be option (C) use your savings to buy well diversified stock mutual fund shares
• The best place to put in the emergency fund would be option (c) Put the money in Roth IRA and invest it in money market mutual funds
• The best life insurance choice would be to buy a small life policy in the beginning and gradually increase the death benefit as you and your spouse age
• All the insurances are worth buying EXCEPT extended warranty on consumer electronics