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March 26, 2023

Exam - Risk and Reward

1) The Florida lottery offers a "cash-three" game, which offers a top prize of $500. Lotto, on the other hand, usually has a $7,000,000 first prize. Since both games cost $1, you should only play Lotto since it has a better payout.

a) True
b) False

2) You are deciding between two mutual funds to place in your IRA (Individual Retirement Account). You find that ING Russia A (LETRX) has earned 55.5% over the past three years while the Perritt Micro Cap (PRCGX) returned only 24.4% over the same period. The Russia fund is obviously better since it returned more money over the same time frame.

a) True
b) False

3) You have several mutual funds that have collectively earned 12% per year over the past couple of years. An acquaintance tells you he manages money and you should let him handle your account because he made 30% last year and 25% the year before. He claims you're foolish to leave your money in such low-performing assets. You should:

a) Transfer your money to him immediately
b) Ask what he's investing in to see if that's in line with your risk tolerances
c) Sue your mutual funds
d) Be very impressed with his stock picking skills

4) You are with a friend at a casino and decide to bet $20 on red at a roulette wheel while your friend decides to play $20 worth of quarters on a slot machine. He tells you that roulette is a bad pick because, if you win, you'll only make $20. But the slot machine he's playing has a $5,000,000 prize! He says it is common sense that it's better to bet 25 cents for the chance to win $5,000,000 rather than to bet $20 for the chance to make $20. You should:

a) Cash in your $20 bill for quarters
b) Realize that slots are better and hunt for a machine with an even higher payout
c) Be very impressed with his game picking skills
d) Understand that there are different risks between the games and make your choice accordingly

5) After the September 11 attacks, the Dow Jones Industrial Average plunged nearly 7% once it reopened for trading on September 17. As for the 30 companies representing that index, nothing changed on their part from September 10 to September 17 yet their prices fell. Why do you suppose that happened?

a) It was due to insider trading
b) Investors were less certain about corporate future earnings due to the attacks. In other words, there was more risk with being invested in stocks and investors bid the prices lower
c) The specialists on the exchange were manipulating prices
d) It was just a coincidence and stock prices could have easily risen on the news

6) Why do you suppose that a used car sold through a dealership is more expensive than an identical one sold through a private seller?

a) Dealerships are a rip-off
b) The dealerships check out the cars and put their "seal of approval" on them. It is less risky buying through a dealership and the market is willing to bid the price higher
c) Private sellers just want to get rid of the car quicker
d) Dealerships mark up the cars too much so that the new cars appear to be a better buy

7) You work for a bank's loan department and find they have loaned money to a dentist at 5% and at 8% to a car salesman for the same loan. Both the dentist and car salesman earned the same amount of money last year and have excellent credit. Why did the bank give a higher rate to the salesman?

a) The bank is just taking advantage of the salesman
b) The dentist must be related to one of the bank employees
c) The salesman's earnings are not as certain as they are for the dentist. Therefore, there is more risk in loaning money to the salesman and the bank needs a higher interest rate to compensate for the risk
d) The salesman didn't negotiate and took their first offer

8) You wish to buy a bond and find that General Motors has issued a one-year bond that pays 2% while the Fly-by-night company has issued a bond that pays 10%. What can you determine by these numbers?

a) The Fly-by-night bond must be riskier and that's why the return on your money is higher (assuming you ever see it).
b) The General Motors bond is riskier and that's why the returns are lower
c) The Fly-by-night bond is a better deal since you make more on your money
d) General Motors is just trying to exercise its power and is offering investors a horrible deal

9) You find a watch on eBay for $1,000. It is brand new but the seller says that all sales are final. The same watch sells for $1,200 in your local mall that does accept returns. Which is a reason it is cheaper on eBay?

a) It is riskier to buy at the mall so their price is higher
b) It is riskier to buy on eBay since you cannot return it. The seller must therefore drop the price in order to compete with the malls
c) It is less risky to buy on eBay so its price is lower
d) The mall just takes advantage of people and charges the highest price

10) For each dollar bet at roulette, a casino offers a $1 payout for betting on red, an $8 payout for a four-number bet, and a $35 payout for a single number. Which bet is riskiest?

a) Red
b) Single number
c) Four number
d) Can't be determined

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