Question

1)For each statement below, list the risk management technique being employed: (4 pts.)

a) Kevin purchases health insurance to help pay for doctor’s visits and medications in case he gets sick as well as for large medical expenses.

b) Sarah decides not to become a doctor since she is afraid of being sued for medical malpractice.

c) Rather than buying life insurance, Dwight has saved up enough money so that his family will be taken care of financially in the event of his premature death.

d) The Smiths install an alarm system in their home to protect against theft and burglary.

2)For an asset or portfolio of assets, the expected return is represented by its ________________ and its risk by its _____________________. (2 pts.)

3)Which of the following would NOT be an example of a loan guarantee?

a. Banks and other issuers of credit cards assuring merchants that they will be paid for all customer purchases.

b. Parent companies paying off the debt of their subsidiaries in the event the subsidiaries are unable to do so.

c. Governments paying off residential mortgages in the event that borrowers default.

d. All of the above are examples of loan guarantees.

4) True/False. The optimal combination of risky assets corresponds to the point of tangency between a graph of all efficient portfolio combinations of two assets and a line which begins at the risk-free rate along the y-axis of the graph.

5) True/False. A person’s preferred portfolio is some combination of the optimal combination of risky assets and the riskless asset and the particular combination chosen depends on the person’s stage in the life cycle, planning horizon, and risk tolerance.

Answer 1

1a). Purchasing insurance is the technique of risk transference as the risk is borne by the insurance company for a price.

1b). Sarah is employing the technique of risk avoidance by not becoming a doctor and thus, avoiding a medical malpractice suit.

1c). Dwight is retaining risk as he find it better to save funds for any future calamity in case of his death that his family might face rather than pay for life insuracne.

1d). Smiths using risk prevention or risk reduction by installing an alarm system as the chances of a theft are reduced due to it.